Finding the Best Index Bond Funds and Avoiding the Worst

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Finding the best bond funds in 2018 may be just as challenging as avoiding the worst bond funds, if the past is any indication. With interest rates and inflation expected to continue rising in 2018, fixed income investing is sure to be a challenge. But there are a few bond fund types that are likely to perform better than others.

The Best Bond Funds for Investing in 2018

Before choosing the best bond funds to buy for any given period of time, keep in mind that bond prices and interest rates have an inverse relationship, which means that bond prices are generally rising when interest rates are falling and bond prices are generally falling when interest rates are rising. Since the current environment is rising rates, many bond funds can see negative returns over the next year.

With that in mind, here are some of the best bond funds to buy in 2018:

  • Total Bond Market Index Funds: Index funds have outperformed actively-managed bond funds in recent years because managers have failed to accurately predict interest rates and the actions of the Federal Reserve. Therefore, a passively-managed bond fund could be your best bet in what may be another unpredictable 2018. The total bond market index usually refers to index mutual funds or Exchange Traded Funds (ETFs) that invest in the Barclay's Aggregate Bond Index, also known as the BarCap Aggregate, which is a broad bond index covering most U.S. traded bonds and some foreign bonds traded in the U.S. Investors can capture the performance of the overall bond market by investing in an index mutual fund or ETF that seeks to replicate the performance of the index. Fund examples include iShares Barclays Capital Aggregate Bond Index (AGG) and Vanguard Total Bond Market Index Fund (VBMFX). However, also keep in mind that index funds are passively managed, which means the manager can't make adjustments for rising rates. Therefore, some index funds could lose to actively-managed funds. In different words, index funds are a good idea in unpredictable environments, when active managers tend to make more mistakes.
  • Bond Funds for Rising Interest Rates: If you believe interest rates and inflation will finally rise in 2015, there are some bond fund types that can reduce interest rate risk. Rising interest rates make prices of bonds go down but the longer the maturity, the farther prices will fall. Therefore the opposite is true: bonds of shorter maturities will do better than those with longer maturities in a rising interest rate environment because their prices. However, keep in mind that "doing better" may still mean falling prices, although the decline is generally less severe. A bond fund that can work well is Vanguard Short-term Bond Index (VBISX). For rising inflation, you might consider using a treasury inflation-protected securities (TIPS) fund. These bond funds can do well just before and during inflationary environments, which often coincide with rising interest rates and growing economies. A standout fund for TIPS is Vanguard Inflation Protected Securites Fund (VIPSX). You may also consider floating rate bond funds, which can adjust to rising rates and potentially perform better than the broad bond market indices.

    The Worst Bond Funds for Investing in 2015

    • Long-term Bond funds primarily invest in bonds that have maturities longer than 10 years. Therefore these bond funds have greater interest rate risk. When interest rates are expected to fall, long-term bonds are an investor's best bet for higher relative returns compared to short and intermediate-term bond funds. The opposite is true in rising interest rate environments (long-term bond prices will fall faster compared to shorter maturities and will likely cause negative returns for a long-term bond fund investor).
    • High Yield (Junk) Bond funds: In addition to interest rates, investors and the capital markets also affect bond prices and yields. As the economy matures and investors begin looking forward to recession, they are not as willing to pay as much in price for a high-risk bond and junk bonds have greater default risk than higher credit quality bonds like US Treasuries.

    Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.