Given the complexities of investing in bonds across many countries and currencies, somewhat higher costs should be expected. However, when one considers all the available low-cost, US bond investment funds (mutual funds and ETFs), there are currently no truly low-cost international bond mutual funds. All reasonably low cost US domiciled international bond funds are ETFs, and none are mutual funds.

This creates an investment implementation dilemma. While global bond fund diversification would be desirable, is it worth owning them, considering the added costs if you are going to utilize mutual funds exclusively and do not wish to be involved with the added complexities of ETFs? In an ideal world for the individual investor, both US domestic and international bond index mutual funds with very low costs would have available, but that is not the current situation.

Cost efficient international bond investing – an index mutual fund dilemma

At this point, there are few even “lower” cost funds international cash or bond mutual funds with acceptable costs. Regarding international bond funds, only two retail international bond mutual funds were found with annual management expense ratios under 1%, and those expense ratios were above .8% per year. Furthermore, these funds have relatively high turnover, which can be an indicator of additional hidden costs related to trading and to short-term returns and non-qualified dividends that would be taxed at ordinary income tax rates.

Other bond mutual funds in the world bond category with have other shortcomings, including:

• unabashed active management with excessively high turnover inappropriate to the duration of the underlying bonds,
• inadequate diversification,
• insufficient total net assets,
• very high investment minimums, and/or
• strategies that involve debt leverage, which amplifies risk.

When the emerging markets bond mutual fund sub-category is considered, expense ratios are even higher, while these other shortcomings persist.

The long-term historical risk premium paid to bondholders of US dollar denominated intermediate-term bonds has been roughly 2.75% in real dollar terms – after 3% inflation has been removed from the analysis. (Since 1926, the compounded annual US dollar domestic inflation rate has been very close to 3% per year.) Thus, even these two international bond mutual funds would consume almost a third of the total historical US bond market real dollar returns – without even considering turnover-trading costs and taxes.

Of course, one might hope that international bond funds would have higher returns than US dollar denominated bond funds, but we always need to keep in mind that risk adjusted returns are what one needs to pay attention – not just relative rates of return. International bond funds would add exposure to exchange rate fluctuations and other additional investment risks. Thus, one would need to evaluate whether there could be a reasonable expectation of significantly higher bond yields to compensate for these substantial costs, the exchange rate risk, and any other risks.

While in general, there are numerous world and emerging markets bond mutual funds, when screened with reasonable selection criteria, none are left to suggest. These international bond mutual funds have far higher fees than domestic bond funds of comparable duration.

Very good news about low cost international bond mutual funds and ETFs

Just as this book was being finalized near the end of 2011, the Vanguard Group filed investment fund registration statements with the Securities and Exchange Commission and announced that it would enter the international bond mutual fund and ETF market. In early 2012, Vanguard will introduce two broadly diversified international bond funds, which are to be named: the Vanguard Total International Bond Index Fund and the Vanguard Emerging Markets Government Bond Index Fund.

Vanguard’s new international bond funds will put significant downward pressure on the US domiciled international bond investment fund market. Vanguard’s announced expense ratios will undercut the competition, particularly with international bond mutual funds. Currently, world bond fund expense ratios average over 1.1% per year, and emerging markets bond fund expense ratios average over 1.3% per year. In addition, it is reasonable to expect that in the coming years Vanguard will expand its offering of international bond funds. Let the price competition begin.

These are the announced expense ratios and investment minimums:

Vanguard Total International Bond Index Fund

• Investor shares (0.40% expense ratio; $3,000 minimum)
• Admiral shares (0.30% expense ratio; $10,000 minimum)
• ETF shares (0.30% expense ratio; no minimum, but brokerage costs)
• Institutional shares (0.25% expense ratio; $5M minimum)

Vanguard Emerging Markets Government Bond Index Fund

• Investor shares (0.50% expense ratio; $3,000 minimum)
• Admiral shares (0.35% expense ratio; $10,000 minimum)
• ETF shares (0.35% expense ratio; no minimum, but brokerage costs)
• Institutional shares (0.30% expense ratio; $5M minimum)

Note that each of these funds will carry a purchase charge, which is not a sales load. The purchase charge for the Total International Bond Fund will be 0.25%, and the purchase charge for the Emerging Markets Government Bond Fund will be 0.75%. Before, Vanguard has instituted purchase charges with some of their international equity funds. A purchase charge is paid into the fund itself. These kinds of purchase charges help to fund the acquisition cost of securities, and they tend to discourage the entry of short-term investors. Since the fees are paid into general fund assets that are owned by shareholders and since long-term investors would amortize these purchase fees over many years, such purchase fees tend to be relatively inconsequential, if not beneficial, to long-term investors.

You could gain international bond exposure economically through ETFs

If you want to include lower cost global and international bond index funds in your portfolio, you could consider bond ETFs. A limited number of international bond ETFs have significantly lower costs compared to international bond mutual funds. However, you would need to keep your trading costs in mind, if you choose international bond ETFs. Furthermore, do not ignore potentially substantial bid-ask spreads and discounts and premiums relative to net asset value.

If you understand how to trade ETFs and can manage a long-term buy-and-hold investment strategy using ETFs in a discount brokerage account, then you have a few low cost international bond ETF choices. Currently, several world bond ETFs with management expenses in the .35% to .50% per year range can be purchased. These funds are reasonably broadly diversified. Moreover, they have portfolio turnover appropriate to the duration of the underlying investments. When compared to similar US dollar denominated bond ETF funds, they have somewhat higher costs but not excessively higher costs.

What to do about international bonds, when using only bond index mutual funds and not ETFs

Using only mutual funds, you might need to get a bit more creative with your investment portfolio.

First, once you understand the concepts involved with investment tax location (See: “Asset allocation, tax location, and emergency cash management”), you will realize that there are tax optimization reasons to hold your allocation to bonds within your retirement accounts. You might get lucky when you look at the international bond mutual fund choices available within your employer sponsored 401k, 403b, 457, or other retirement plan. You might find that a not-so-expensive international bond institutional fund has been made available to you and that could do the trick.

Another alternative would be to make some modest adjustments to your US versus international equity mutual fund proportions. Without economical, international mutual funds for your cash and bond allocations, all of your cash and bond investments would be US dollar denominated. If you were hesitating to hold at least 50% of your equity allocation in non-US stock mutual funds, as would be suggested by the fact that well over half the world’s total stock capitalization value is now in countries outside the US, then this might provide even more support for increasing your international stock allocation.

If you cannot get economical international exposure via bond mutual funds, you certainly can do so with low cost international stock mutual funds. Broadly diversified international equity mutual funds can be purchased at a much more reasonable cost than international bond mutual funds. While this is a different kind of investment exposure, a modest allocation shift could substitute until sometime in the future – when low-cost international bond index mutual funds become more widely available for reliable low-cost mutual fund vendors.

Regarding cash and short-term cash equivalent investments, to hold any of your cash allocation in non-US dollar denominated securities would simply expose you to shorter-term currency exchange rate risk. This contradicts some of the normal objective related to the cash portion of your investment portfolio, which is to reduce risk and value fluctuations.

Usually an investor holds some portion of their overall investment portfolio in cash designed to cover expenses for some months to some years going forward. Should the investor need this cash, it would be more prudent to have those cash holding be denominated in US dollars, since they would need to pay their expenses in US dollars. Certainly, prices of imported goods could change, but most goods and services that are consumed are domestically produced and dollar denominated.

In addition, despite the securities industry’s completely irresponsible promotion of currency trading to retail investors, the currency markets are no place whatsoever for an individual investor. Currency trading is a zero sum game that places a premium on up-to-the-second real-time information about worldwide developments affecting the currency markets, about flows of funds, and about shifting governmental policies and practices.

Furthermore, knowledgeable and efficient foreign exchange trading occurs at dollar volumes that are far out of reach of the average retail investor. When individual investors engage in foreign exchange trading, it is like a puny human trying to get close to a casino craps table run by elephants. In short, the odds do not favor the human having any reasonable chance even to get up to an efficient trading table – let alone trade profitably against professional traders. If individual investors carefully consider the situation, they will stay far away from foreign exchange trading.

This “top 10 + 4″ article discusses the top 14 low cost taxable US fixed income funds, with low minimum deposits. In this article, we consider taxable bond funds with a $10,000 maximum initial deposit for a taxable account. Required minimum deposits in the list below are $3,000 for the 13 Vanguard bond funds and $10,000 for the Fidelity fund. The primary objective of this article is to identify low cost taxable bond funds, because low investment management fees are very important when selecting fixed income funds. This article will explain why.

Now, if you are one of those high savers who has been socking money away for a long time, you might have $100,000 or more to invest in a low cost bond fund. If you have a hundred grand for a single taxable bond investment fund, then you can buy a bond mutual fund with an even lower investment management expense ratio. We have also written a United States bond article that lists the Top 11 Lowest Cost Taxable US Fixed Income Mutual Funds, if you can make the higher minimum deposit of over $100,000.

When you review the bond funds list below, you will immediately notice that, except for a single fund offered by Fidelity, every other fund is offered by The Vanguard Group mutual fund company. This is not surprising, because Vanguard’s long term business strategy has been to offer the best bond market index funds at the lowest costs. Vanguard dominates this low cost United States bond mutual funds marketplace for direct purchase accounts with both low and high minimum deposits.

What is important when you buy taxable bond funds?

Investment research overwhelmingly shows that lower cost fixed income funds tend to yield higher bond investing returns. The fixed income asset market is no place for you to try to beat the market and to attempt to get higher returns by active bond investing. Even professional fixed income asset market money managers do not beat the bond market. The higher the mutual fund company expenses, the lower the net returns to individual investors.

Professional fixed income asset market money managers do not achieve high enough returns to cover their higher fees. As a result, these higher costs cause you to get inferior net returns. You pay more. You get less.

Read this article to understand why paying higher bond mutual fund fees will most often create a “deadweight” loss for you: Bond Mutual Fund Fees. This article about the high investment management costs of fixed income funds summarizes three studies. All three of these cost evaluation studies about United States bond mutual funds clearly show that the more you pay for bond funds, the less you tend to get.

Our sister website, Best NoLoad Mutual Funds, provides an explanation of 7 factors that can help you to choose the best mutual funds and ETFs. Click any of the numbered subheadings in that article to find another article about that each selection factor for choosing bond market index funds.

Regarding choosing bond funds from a fixed income asset market mutual fund company, the process of picking fixed income funds can be even more straightforward. We also have additional articles about investing in fixed income funds and bond ETFs. These articles provide more detailed explanations of why you get less with bond funds that have higher management expense ratios. See these articles: No Load Bond Funds, Bond Mutual Fund Fees, and Bond Index Funds.

The list of the top 14 low cost taxable United States bond mutual funds with initial investments at or below $10,000

We have ordered the table of low cost United States bond mutual funds below by increasing annual management expense ratio. However, all these bond funds have management expense ratios that are very low. When investing in fixed income funds you need to decide the type of bond fund by bond quality (default risk) and bond duration. Bond duration is the weighted average of the expected cash flows for the bonds in the portfolio.

In addition to default risk and bond duration, lower bond mutual fund fees have been shown to have a significant impact on expected bond yields. Note also that the average bond duration for these bond funds will influence their rates of portfolio turnover. Over 90% of the portfolio assets of these funds are invested in bonds and fixed income securities. Most have very close to 100% of their assets in bond securities. All these funds were believed to be open to new investors at the time of writing.

Concerning annualized 3-year investment returns, it is not be appropriate to compare returns across this list of the top 14 low cost United States bond mutual funds. Due to the mixture of bond durations and other factors, this would be an apples and oranges comparison. Furthermore, the credit crunch related to the subprime mortgage crisis and the collapse of the housing bubble caused a flight to insured government bonds funds, which negatively affected prices of other non-insured bonds of varying credit quality.

The top 14 low cost United States taxable bond mutual funds with initial deposit requirements at or below $10,000

See the notes at the bottom of this table.*

#1) Vanguard Long Term Bond Index Fund – Investor Shares Class – VBLTX

Annual Management Expense Ratio _____0.19%
Annual Portfolio Turnover _____________67%
Total Portfolio Assets ($B) _____________$2.8
Taxable Account Minimum Investment ____$3,000

#2) Vanguard Short Term Bond Index Fund – Investor Shares Class – VBISX

Annual Management Expense Ratio _____0.19%
Annual Portfolio Turnover _____________101%
Total Portfolio Assets ($B) _____________$10.5
Taxable Account Minimum Investment ____$3,000

#3) Vanguard Intermediate Term Bond Index Fund – Investor Shares Class – VBIIX

Annual Management Expense Ratio _____0.18%
Annual Portfolio Turnover _____________86%
Total Portfolio Assets ($B) _____________$3.2
Taxable Account Minimum Investment ____$3,000

#4) Vanguard Short Term Federal Fund – Investor Shares Class – VSGBX

Annual Management Expense Ratio _____0.19%
Annual Portfolio Turnover _____________89%
Total Portfolio Assets ($B) _____________$8.6
Taxable Account Minimum Investment ____$3,000

#5) Vanguard Inflation-Protected Securities Fund – Investor Shares Class – VIPSX

Annual Management Expense Ratio _____0.20%
Annual Portfolio Turnover _____________28%
Total Portfolio Assets ($B) _____________$19.3
Taxable Account Minimum Investment ____$3,000

#6) Vanguard Total Bond Market Index Fund – Investor Shares Class – VBMFX

Annual Management Expense Ratio _____0.20%
Annual Portfolio Turnover _____________61%
Total Portfolio Assets ($B) _____________$54.0
Taxable Account Minimum Investment ____$3,000

#7) Fidelity Spartan Intermediate Treasury Bond Index Fund – Investor Class – FIBIX

Annual Management Expense Ratio _____0.20%
Annual Portfolio Turnover _____________85%
Total Portfolio Assets ($B) _____________$1.6
Taxable Account Minimum Investment ____$10,000

#8) Vanguard Short Term Investment Grade Fund – Investor Shares Class – VFSTX

Annual Management Expense Ratio _____0.21%
Annual Portfolio Turnover _____________49%
Total Portfolio Assets ($B) _____________$20.4
Taxable Account Minimum Investment ____$3,000

#9) Vanguard GNMA Fund – Investor Shares Class – VFIIX

Annual Management Expense Ratio _____0.21%
Annual Portfolio Turnover _____________63%
Total Portfolio Assets ($B) _____________$32.6
Taxable Account Minimum Investment ____$3,000

#10) Vanguard Intermediate Term Investment Grade Fund – Investor Shares Class – VFICX

Annual Management Expense Ratio _____0.21%
Annual Portfolio Turnover _____________48%
Total Portfolio Assets ($B) _____________$9.6
Taxable Account Minimum Investment ____$3,000

#11) Vanguard Long Term Investment Grade Fund – Investor Shares Class – VWESX

Annual Management Expense Ratio _____0.22%
Annual Portfolio Turnover _____________24%
Total Portfolio Assets ($B) _____________$5.8
Taxable Account Minimum Investment ____$3,000

#12) Vanguard High Yield Corporate Fund – Investor Shares Class – VWEHX

(See the note below.)

Annual Management Expense Ratio _____0.21%
Annual Portfolio Turnover _____________47%
Total Portfolio Assets ($B) _____________$8.0
Taxable Account Minimum Investment ____$3,000

#13) Vanguard Long Term Treasury Fund – Investor Shares Class – VUSTX

Annual Management Expense Ratio _____0.26%
Annual Portfolio Turnover _____________80%
Total Portfolio Assets ($B) _____________$3.4
Taxable Account Minimum Investment ____$3,000

#14) Vanguard Intermediate Term Treasury Fund – Investor Shares Class – VFITX

Annual Management Expense Ratio _____0.26%
Annual Portfolio Turnover _____________88%
Total Portfolio Assets ($B) _____________$7.1
Taxable Account Minimum Investment ____$3,000

Note on #12 VWEHX: This United States bond mutual funds charges a 1% fee on the sale of shares held under one year. This redemption fee is paid to the fund and benefits the fund’s remaining shareholders. Thus, it is not a back end load.

Notes about this list:
1) You can just buy index funds directly from an mutual fund company that wants direct relationships with the investing public. You do not have to waste your hard-earned money on the sales loads and 12b-1 fees that deplete your investment assets, when you buy through a financial advisor or investment counselor. Because all but one of these top 14 low cost United States bond mutual funds are offered by Vanguard, we have not provided links above to the specific funds. Instead, use these links to find these funds on the Vanguard website:

• Vanguard Funds by Asset Class. Change the Share Class in the pull down menu to Admiral Shares. Click the name of the bond fund and verify the ticker symbol.
• Vanguard main website for individual investors
• To find the main Fidelity Investments website, click on this link: Fidelity Investments. To find a particular mutual fund, enter the funds ticker symbol in the search box at the top of the page.

2) This list of the top 14 low cost United States bond mutual funds was developed using data base screening methods, which excluded United States bond mutual funds that did not meet the selection criteria. No analysis or due diligence of any kind was performed on any of these top 14 low cost United States bond mutual funds. This list of top 14 low cost United States bond mutual funds is solely for your information and is not investment advice or a solicitation or offer to sell securities or other financial services. There could be errors with this information, and it is your responsibility to verify all information, before you make any personal financial decision.

How this list of the top 14 low cost taxable United States bond mutual funds was developed

To develop this list we used the screening methods described below and applied them to data from early in Q2 of 2009. We have found that lists of low cost investment mutual funds and ETFs developed using these screening methods tend to be quite stable over time. Things may have changed since this article was written, and you should always verify information before investing.

The reasons are quite simple why a list like this tends to be relatively stable. If an mutual fund company competes on price, it keeps competing on price. If it offers low turnover, low fee, passively managed index mutual funds, it tends to keep offering the same.

The top 14 low cost United States bond mutual funds in the list below were selected using a process of elimination following the Best No Load Funds selection criteria. As a starting point the universe of potential United States bond mutual funds was obtained using data from Lipper and/or Morningstar. United States bond mutual funds include US Treasury, US Agency, GNMA, and corporate debt obligations – all with a range of durations and quality.

This universe of mutual funds and ETFs was then automatically screened according to these fund selection rules:

• No charges for 12b1 fees and mutual fund sales loads. (None of these fixed income funds have financial advisor sales load charges nor any 12b1 fees.),
• Lower investment management expenses (All have extremely low asset management fees),
• Lower portfolio turnover (Turnover is low to moderate for most of these funds. Shorter duration pushes up turnover and the credit crunch has also had an impact.),
• Avoid very large actively managed mutual funds (None seemed to be, although FIBIX seemed to be modestly leveraged.),
• Avoid very new mutual funds (All funds are at least three years old, except the FIBIX fund, which was about 2.5 year old at the time of writing.),
• Eliminate very small mutual funds (All funds have at least $.5B in portfolio value.), and
• Screen out inferior ETF and mutual fund performance (None had consistently inferior 1-year, 3-year, and 5-year performance. Most had investment performance in the upper quartile of their comparison group, although several had some difficulties largely due to the credit crunch and monetary policy.)

With these selection criteria, you inevitably end up with a much smaller list of mutual funds and ETFs. Remaining investment funds are almost inevitably passively managed index funds, because low cost structures cannot support the investment management activities required to pursue more risky, active strategies.

In addition, the resulting list is quite small relative to the very large universe of mutual funds and exchange traded funds that we began with. This is simply because the vast majority of investment funds are actively managed funds, which are far more likely to make money for the mutual fund company, than they are to make money for you. See this article on our sister website, The Skilled Investor, The illusion of superior professional mutual fund manager performance.

When you screen investment funds in almost any investment asset category and rank them from lower to greater investment management ratios, the resulting investment fund lists tend to be populated by funds from a handful of investment management companies. An mutual fund company sets its business strategy, and some (too few) of them have decided to compete on the basis of low costs and efficiency. These low cost investment fund companies tend to do a better job of serving the interests of individual investors.

This “top 10 + 1″ article discusses the top 11 low cost US taxable bond mutual funds, if you have $100,000 to invest. Now, you say that you do not have a hundred grand for a single bond market investment fund? Well, all is not lost for you (and for most other people). Elsewhere on this bond index funds website, we have published a US bond article that lists the Top 14 Low Cost Taxable US Bond Mutual Funds that have much lower initial contribution requirements. This other taxable US bond article covers taxable US fixed income mutual funds that require much lower initial investments for taxable fixed income funds.

When you review the taxable fixed income funds list below, you will immediately notice that every fund is offered by The Vanguard Group investment company. This is not surprising, because Vanguard’s long term business strategy has been to offer the best index mutual funds at the lowest costs. Vanguard dominates this low cost US fixed income mutual funds marketplace.

What is important when you buy taxable fixed income funds?

Most importantly, the investment research literature indicates that lower cost bond mutual funds tend to yield higher fixed income investing returns. The bond market is no place for an individual investor to try to beat the market and get higher returns through attempts at clever fixed income investing. Even professional bond market money managers do not beat the bond market. The higher their fund charges, the further they fall behind.

The failure of professional bond market money managers to deliver higher returns to justify their higher fees is thoroughly documented in the research literature. To better understand why paying higher bond mutual fund fees creates a “deadweight” loss to individual investors, see this Bond Mutual Fund Fees article elsewhere on this website. This article about the unjustifiably high investment management costs of bond mutual funds summarizes three studies. All three of these cost evaluation studies about US fixed income mutual funds clearly show that the more you pay for fixed income funds, the less you get.

Our sister website, Best NoLoad Mutual Funds, provides some scientific criteria for selecting the best mutual funds and ETFs. Click any of the numbered subheadings in that article, and you will find a more detailed article about that particular selection criteria for choosing index mutual funds.

Regarding selecting fixed income funds from a bond market investment company, the process of choosing bond mutual funds can be even more straightforward. On this website, you will find additional articles about investing in bond mutual funds and bond ETFs. These articles indicate that the more you pay when you buy fixed income funds, the less you get. See these articles: No Load Bond Funds, Bond Mutual Fund Fees, and Bond Index Funds.

The list of the top 11 low cost taxable US fixed income mutual funds, when you have $100,000 to invest

The table of low cost taxable US fixed income mutual funds below is arranged by increasing annual management expense ratio. However, all these fixed income funds have management expense ratios that are very low. When investing in bond mutual funds you need to decide the type of bond fund by bond quality (default risk) and bond duration. Bond duration is the weighted average of the expected cash flows for the bonds in the portfolio.

In addition to default risk and bond duration, lower bond mutual fund fees have been shown to have a significant impact on expected bond yields. Note also that the average bond duration for these fixed income funds will influence their rates of portfolio turnover. Over 90% of the bond portfolio assets of these funds invested in bonds and fixed income securities. Most have very close to 100% of their assets in long bond secuities. All these funds were believed to be open to new investors at the time of writing.

With annualized 3-year investment returns, it would not be appropriate to compare returns across this list of the top 11 low cost US fixed income mutual funds. Such a comparison would be an apples and oranges comparison, due to the mixture of bond durations and other factors. Furthermore, the credit crunch related to the subprime mortgage crisis and the collapse of the housing bubble caused a flight to insured government bonds funds, which negatively affected prices of other non-insured bonds of varying credit quality.

See the notes at the bottom of this table.*

#1) Vanguard Long Term Treasury Fund – Admiral Share Class – VUSUX

Annual Management Expense Ratio _____0.10%
Annual Portfolio Turnover _____________80%
Total Portfolio Assets ($B) _____________$3.4
Taxable Account Minimum Investment ____$100,000

#2) Vanguard Short Term Federal Fund – Admiral Share Class – VSGDX

Annual Management Expense Ratio _____0.10%
Annual Portfolio Turnover _____________109%
Total Portfolio Assets ($B) _____________$4.0
Taxable Account Minimum Investment ____$100,000

#3) Vanguard Short Term Investment Grade – Admiral Share Class – VFSUX

Annual Management Expense Ratio _____0.10%
Annual Portfolio Turnover _____________49%
Total Portfolio Assets ($B) _____________$20.4
Taxable Account Minimum Investment ____$100,000

#4) Vanguard Intermediate Term Treasury Fund – Admiral Share Class – VFIUX

Annual Management Expense Ratio _____0.10%
Annual Portfolio Turnover _____________88%
Total Portfolio Assets ($B) _____________$7.1
Taxable Account Minimum Investment ____$100,000

#5) Vanguard Intermediate Term Investment Grade – Admiral Share Class – VFIDX

Annual Management Expense Ratio _____0.10%
Annual Portfolio Turnover _____________48%
Total Portfolio Assets ($B) _____________$9.6
Taxable Account Minimum Investment ____$100,000

#6) Vanguard GNMA Fund – Admiral Share Class – VFIJX

Annual Management Expense Ratio _____0.11%
Annual Portfolio Turnover _____________63%
Total Portfolio Assets ($B) _____________$32.6
Taxable Account Minimum Investment ____$100,000

#7) Vanguard Total Bond Market Index Fund – Admiral Share Class – VBTLX

Annual Management Expense Ratio _____0.11%
Annual Portfolio Turnover _____________61%
Total Portfolio Assets ($B) _____________$54.0
Taxable Account Minimum Investment ____$100,000

#8) Vanguard Short-Term Bond Index Fund – Admiral Share Class – VBIRX

Annual Management Expense Ratio _____0.11%
Annual Portfolio Turnover _____________101%
Total Portfolio Assets ($B) _____________$10.5
Taxable Account Minimum Investment ____$100,000

#9) Vanguard Intermediate Term Bond Index Fund – Admiral Share Class – VBILX

Annual Management Expense Ratio _____0.11%
Annual Portfolio Turnover _____________89%
Total Portfolio Assets ($B) _____________$8.6
Taxable Account Minimum Investment ____$100,000

#10) Vanguard Long Term Investment Grade Fund – Admiral Share Class – VWETX

Annual Management Expense Ratio _____0.12%
Annual Portfolio Turnover _____________24%
Total Portfolio Assets ($B) _____________$5.8
Taxable Account Minimum Investment ____$100,000

#11) Vanguard High Yield Corporate Fund – Admiral Share Class – VWEAX

(see note below)

Annual Management Expense Ratio _____0.13%
Annual Portfolio Turnover _____________21%
Total Portfolio Assets ($B) _____________$8.0
Taxable Account Minimum Investment ____$100,000

Note on #11 VWEAX: This US fixed income mutual funds charges a 1% redemption fee on the sale of shares held under one year. This redemption fee is paid to the fund’s remaining shareholders, and thus it is not a back end load.

Notes about this list:
1) You can just buy index funds directly from an investment company that wants direct relationships with the investing public. You do not have to waste your hard-earned money on the sales loads and 12b-1 fees that deplete your investment assets, when you buy through a financial advisor or investment counselor. Because all of these top 11 low cost US fixed income mutual funds are offered by Vanguard, we have not provided links above to the specific funds. Instead, use these links to find these funds on the Vanguard website:

• Vanguard Funds by Asset Class. Change the Share Class in the pull down menu to Admiral Shares. Click the name of the bond fund and verify the ticker symbol.
• Vanguard main website for individual investors

2) This list of the top 11 low cost US fixed income mutual funds was developed using data base screening methods, which excluded US fixed income mutual funds that did not meet the selection criteria. No analysis or due diligence of any kind was performed on any of these top 11 low cost US fixed income mutual funds. This list of top 11 low cost US fixed income mutual funds is solely for your information and is not investment advice or a solicitation or offer to sell securities or other financial services. There could be errors with this information, and it is your responsibility to verify all information, before you make any personal financial decision.

How this list of the top 11 low cost taxable US fixed income mutual funds was developed

To develop this list we used the screening methods described below and applied them to data from early in Q2 of 2009. We have found that lists of low cost investment mutual funds and ETFs developed using these screening methods tend to be quite stable over time. Things may have changed since this article was written, and you should always verify information before investing.

The reasons are quite simple why a list like this tends to be relatively stable. If an investment company competes on price, it keeps competing on price. If it offers low turnover, low fee, passively managed index mutual funds, it tends to keep offering the same.

The top 11 low cost US fixed income mutual funds in the list below were selected using a process of elimination following the Best No Load Funds selection criteria. As a starting point the universe of potential US fixed income mutual funds was obtained using data from Lipper and/or Morningstar. US fixed income mutual funds include US Treasury, US Agency, GNMA, and corporate debt obligations – all with a range of durations and quality.

This universe of mutual funds and ETFs was then automatically screened according to these fund selection rules:

• No charges for 12b1 fees and mutual fund sales loads. (None of these bond mutual funds have financial advisor sales load charges nor any 12b1 fees.),
• Lower investment management expenses (All have extremely low asset management fees),
• Lower portfolio turnover (Turnover is low to moderate for most of these funds. Shorter duration pushes up turnover and the credit crunch has also had an impact.),
• Avoid very large actively managed mutual funds (None are.),
• Avoid very new mutual funds (All funds are at least three years old.),
• Eliminate very small mutual funds (All funds have at least $.5B in portfolio assets.), and
• Screen out inferior ETF and mutual fund performance (None had consistently inferior 1-year, 3-year, and 5-year performance. Most had investment performance in the upper quartile of their comparison group, although several had some difficulties due in part to the credit crunch and changes in monetary policy.)

With these selection criteria, you inevitably end up with a much smaller list of mutual funds and ETFs. Remaining investment funds are almost inevitably passively managed index funds, because low cost structures cannot support the investment management activities required to pursue more risky, active strategies.

In addition, the resulting list is quite small relative to the very large universe of mutual funds and exchange traded funds that we began with. This is simply because the vast majority of investment funds are actively managed funds, which are far more likely to make money for the investment company, than they are to make money for you. See this article on our sister website, The Skilled Investor, The illusion of superior professional mutual fund manager performance.

When you screen investment funds in almost any investment asset category and rank them from lower to greater investment management ratios, the resulting investment fund lists tend to be populated by funds from a handful of investment management companies. An investment company sets its business strategy, and some (too few) of them have decided to compete on the basis of low costs and efficiency. These low cost investment fund companies tend to do a better job of serving the interests of individual investors.

Bond portfolio management is a relatively specialized fixed income securities activity. You might expect that certain bond mutual fund managers would be more skilled than others and would produce higher bond returns. Better performance due to investment skill could, of course, justify paying extra fees.

However, investment science has not detected a relationship between paying higher fees and obtaining better returns from the bond mutual fund industry. In fact, the opposite seems to be true. Higher expenses tend to mean lower net returns to individual investors. [See: Bond Mutual Fund Fees]

While different from the equity markets, the bond markets also tend to be relatively efficient from the standpoint of reflecting currently available information in prices. They are simply not easy to beat in the sense that it is difficult or impossible to detect and capitalize on mis-pricing. Nevertheless, transactions or trading fees are relatively high — especially for individual investors purchasing fixed income securities instead of fixed income investment funds. [See: Bond Market Index Funds]

Buy no load bond funds to get the best bond fund performance

Once an individual investor has decided to purchase shares in a bond mutual fund, the selection process can be relatively straightforward. Bond mutual funds are just another financial product being marketed to fill an investment need. The fund companies that offer them make decisions on how they will compete – whether through advertising, agents, service, word-of-mouth, etc. Some fixed income funds compete on price, i.e. lower fees, and others do not. Patronize funds that compete on price, that is, they offer rock bottom management expense ratios.

To protect your interests – instead of the interests of the mutual fund companies – you need simply to determine the style of fund you desire in terms of bond maturity and investment quality. Then, from among the funds with the lowest fees, just pick one or preferably several bond mutual funds — several for greater investment diversification — that are offered by reputable firms. If you pay higher fees, you will most likely just throw your money down a securities industry profit hole.

Just say NO to bond fund sales loads

If you are dealing with any investment counselor or financial advisor who tries to promote a bond market mutual fund with high fees and/or a bond mutual fund with a front-end load, just say no. Investment science indicates that there is no justification for paying higher expenses or a front-end load. Higher sales load expenses just tend to lower your total returns.

A front-end load just means that you are paying someone to sell you an investment. Paying extra to be sold to is hard to justify in any type of business transaction – whether in investments or in any other industry. It is easy to buy directly from bond market mutual funds and cut out the intermediary. Fixed income fund families that want your direct business all have how-to-buy information on their websites and toll free customer service telephone numbers.

Sales loads are an extremely expensive way to pay a financial advisor. If you need a financial advisor, find one who accepts hourly or fixed fee compensation and does not take any commission money from the industry through the “back door.” Also, if your financial adviser pushes fixed income investment funds with high expense ratios, this is an indication that they have not done their homework. Either that or they care more about their own compensation than they do about your financial outlook. Get a better financial advisor who will look out for your interests and save you money over the long haul.

Fixed income fund redemption fees

In addition, note that there can be a reasonable justification to pay a short-term, back-end redemption charge. If a fund has a longer average maturity and wishes to discourage shorter-term trading behavior, a redemption charge could be assessed for some limited period following a purchase to protect longer-term fund holders.

A short-term redemption charge is not a back-end load. Back-end loads pay bond financial advisors, investment counselors, and their firms. Instead, redemption charges are paid (or should be – check to find out) to the shareholders of the fund. Redemption fees should be designed to compensate long-term shareholders for any higher trading costs and/or higher short-term capital gains taxes caused by short-term share trading.

If a fund has such a redemption fee and you agree with why it is there, then you should confirm that all such fees collected are returned to the fund itself solely for the benefit of fund investors who stay in the fund for a longer period. In addition, of course, you need to make sure that it is highly unlikely that you will need to redeem your investment within this penalty window.

Note also that some very low cost no load bond market index funds may have longer-term back end redemption fees that are paid to remaining shareholders and only expire after multiple years. This is a clear signal that the fund is designed for both cost efficiency and long-term investors. A modest multi-year redemption fee (perhaps 1% or less paid upon exit before some number of years) might not be a bad idea for very low cost no load bond funds.

With a stay put, buy-and-hold shareholder clientele, you could benefit from very low annual costs, very low portfolio turnover and trading costs, and redemption fee “protection” from frequent early exits and churning by those with a short-term trading perspective. Again, consider the likelihood of you being a long-term holder who would benefit from others who exit early, versus you needing to exit early and pay the redemption fee yourself.

Bond trading is a very complex process that individual investors should leave to professional fund managers. The pricing and trading of bonds and fixed income securities is far more convoluted than for common stocks or equities. Furthermore, bond pricing is much less transparent and has wide spreads. In a very real sense, you buy at retail prices and sell at wholesale prices.

Securities pricing in the bond market is much different from the stock market. While a firm usually has only one kind of common stock, it could have dozens or even hundreds of different outstanding fixed income securities. Few individual investors have the required skill, knowledge, information, and experience to assess bond market prices.

Fixed income securities or bonds have different valuation characteristics than do common stock securities, and bonds require different valuation methods. Common stock investments give the investor a claim to part of the market value of the firm and to its dividends, if the Board of Directors declares any such payments.

Compared to common stock held by shareholders, corporate bonds give their holders a more senior claim to the firm’s cash flow to pay bond interest and principal payments. If bondholders’ claims cannot be met, then default and bankruptcy may occur. The firm could be forced to sell or liquidate, and equity ownership could pass to its creditors and bondholders. Such events are usually very difficult, slow, and distasteful processes.

Figuring out whether bond obligations are likely to be fulfilled by issuers during the term of the bond is best left to professional bond investment specialists. This is called the default risk. Expectations about the varying potential for default can cause substantial price differences for bonds that otherwise have similar terms.

Investors can achieve higher returns by choosing the lowest cost bond market index funds

No load bond funds also can also provide a very high degree of fixed income securities investment diversification, and no load mutual funds can do this very economically. For individual investors it simply is much more straightforward to hold bonds through a bond fund.

Once a bond fund establishes its “style” for the type, maturity, and quality of bonds it will hold, it purchases and holds bonds with an eye toward maintaining that style. Maintaining targeted maturity is relatively straightforward. Determining investment quality is less straightforward, but bond mutual funds have analysts on staff and have access to the analytic services of bond ratings houses like Moody’s, Standard and Poor’s, and Fitch Ratings.

Bond market index funds offer a far higher degree of investment portfolio diversification

No load bond funds provide the investment risk reduction associated with market diversification. Investors can achieve fixed income securities diversification far more economically than they could through the direct purchase of individual bonds.

Fixed income mutual funds offer additional trading efficiency advantages to individual investors. The professional traders of bond mutual funds can conduct fixed income securities trading much more efficiently. Furthermore, fixed income funds trade substantial volume, which gives them leverage in negotiations and the ability to trade with different partiesthe. Individual investors have no such leverage, and they must take or leave the price they are given. Therefore, individuals buy at retail prices and sell at wholesale prices — often paying substantially higher spreads than professional fixed income securities traders do.

Without knowing it, bond market trading of individual fixed income securities can be very expensive for individual investors. Individual investors simply cannot tell whether they are getting a fair market price. Sometimes, individual investors pay very high spreads and transaction expenses, when they buy or sell individual bond securities. This is not an issue of bond market inefficiency. Rather, it is a problem of grossly unfair treatment aided to the obscurity of the bond market pricing process and the willingness of certain traders to take full advantage of individual investors.

Simply put, if you pay higher bond mutual fund fees, then these bond management expenses tend just to be a “deadweight” loss to you. The best bond fund buying strategy is to pick only very low-cost no load bond funds.

In pursuit of higher risk-adjusted bond mutual fund returns, many investors wonder whether it is worth paying higher expenses and fees. If they do pay more, will they get better mutual fund performance? Will higher performance outweight the added expenses? Investment science provides a strong “no” as the answer. When you pay more in bond mutual fund fees, you are just wasting your money.

Higher bond mutual fund fees hurt the performance of all types of fixed income funds

In “Bond Fund Returns and Expenses: A Study of Bond Market Efficiency,” Professor William Reichenstein of Baylor University studied the relationship between bond mutual fund returns and expenses.¹ Professor Reichenstein analyzed bond mutual fund expenses and returns for the years 1994 to 1998.

To ensure that he was comparing bond funds of similar characteristics, Professor Reichenstein grouped bond mutual funds by their investment styles. Fund groups were differentiated by maturity (short-, medium-, long-term maturities) and investment grade quality (low, medium, high quality). Within each of the nine combinations of these maturity and quality style groups, he assigned each individual fixed income fund to one of three equal sized groups according to the fund’s expense ratio (low, medium, high expenses).

Professor Reichenstein tested several theories about investment returns and expenses over 1-year, 3-year, and 5-year time horizons by comparing average investment returns between these nine maturity and quality groupings. For example, he compared the average net return of the low cost group to the medium cost and the high cost groups of the same style to see whether higher fees produced greater returns, and so on. Without failure, Professor Reichenstein found that higher expenses predicted lower returns in 42 out of the 42 group comparisons.

Professor Reichenstein cited other studies of fixed income mutual funds expense and return averages that yielded similar results. For example, Jonathan Clements used Morningstar data that grouped bonds into five categories: government backed mortgage, corporate, U.S. Treasury, general municipal, and high-yield bonds.² Clements found that in 28 out of 30 comparisons higher expenses meant lower returns to the investor. In 1999, Clements updated his 1991 study and found that higher expenses still meant lower returns to the investor, this time in 15 out of 15 cases.³

Again, higher bond mutual fund expenses lead to lower bond mutual fund performance

In addition, in 1999 John Bogle analyzed bond maturity and quality groupings for government, corporate, and municipal funds.⁴ He found that in 24 out of 24 comparisons higher expenses meant lower returns. In summary, 109 of the 111 comparisons in these four studies indicated that higher average expenses meant lower returns to investors.

Superior performance of specific bond mutual funds could have been obscured by comparing only the averages between groups. Therefore, Professor Reichenstein tested whether individual funds within his maturity and quality groupings delivered returns that compensated for their higher expenses. Again, his conclusion was no.

In fact, his analysis indicated that higher bond mutual fund expenses were a dollar for dollar “deadweight loss.” The higher the expenses, the lower the net return was for the individual investor. Professor Reichenstein’s analysis also concluded that the performance of similar bond funds with and without front-end loads was not statistically distinguishable. Additional expenses and investment broker sales loads just tended to result in a dollar-for-dollar reduction in investor’s assets.

Pay more to get less. Hmmmmm… Since when is that at good idea? Save your money. Ignore what commissioned bond mutual fund brokers and investment counselors tell you. Higher costs and sales loads to not deliver better bond mutual funds. Seek out and buy low cost, no load bond funds. Buy them directly from the mutual fund company to save money. It is your money. Hold on to it!

Footnotes:

1) Reichenstein, William. “Bond Fund Returns and Expenses: A Study of Bond Market Efficiency.” Journal of Investing, Winter 1999: 1-9
2) Clements, Jonathan. “In Picking Bond Fund, Expense Factor Remains the Key.” Wall Street Journal, April 4, 1991, p. C1.
3) Clements, Jonathan. “If Your Manager is So Smart, Why are his Expenses So High?” Wall Street Journal, July 6, 1999, p. R1.
4) Bogle, John, C. Bogle on Mutual Funds: New Perspectives for the Intelligent Investor. Burr Ridge, Il: Irwin, 1994