The Best Index Funds for Bonds

We Picked the Best Bond Index Funds to Buy From Vanguard and Fidelity

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When investors mull the best index funds, Vanguard Investments usually come to mind. The investing community considers the firm to be the king of low-cost investing and many of the best bond index funds are in the Vanguard lineup. There are still a handful of good choices at other fund companies, however, primarily from Vanguard rival Fidelity Investments.

With that in mind, here are the best bond index funds in different categories, which cover all of the major bond types.

Best Index Funds for the Total Bond Market

If you're looking for one good bond fund to hold, or you need a solid core holding for a fixed income portfolio, total bond market funds are a wise choice. Here are a few of the best:

Vanguard Total Bond Market Index (VBMFX): The biggest bond fund in the world, VBMFX, offers shareholders exposure to the entire universe of the U.S. bond market, which includes more than 8,000 bonds. The fund invests 30 percent in corporate bonds and 70 percent in U.S. government bonds of all maturities: short-, intermediate-, and long-term issues. 

Fidelity Total Bond (FTBFX): Termed a "bond multi-vitamin," this is a core holding that offers exposure to a broad range of fixed income assets. Over time, these have included
broad exposure to government and investment-grade corporate bonds and opportunistic high-yield investments. The fund normally invests at least 80 percent of assets in debt securities of all types and repurchase agreements for those securities.

Best Index Funds for Long-Term Bonds

Long-term bond funds tend to perform best when interest rates are falling but if you want to add a long-term bond fund to your portfolio, index funds can be a good choice. Vanguard and Fidelity again have some of the top funds in this category:

Vanguard Long-Term Bond Index (VBLTX): If you want broad exposure to the long-term bond market, this fund offers it here. This index fund has a diversified approach to bond investing and is low-cost. It provides broad exposure to U.S. investment-grade bonds with maturities of more than ten years. The fund invests about 60 percent of assets in corporate bonds and 40 percent in U.S. government bonds. 

Fidelity Long-Term Treasury Bond Index (FLBIX): The fund normally invests at least 80 percent of assets in securities included in the Bloomberg Barclays U.S. Long Treasury Index. It typically maintains a dollar-weighted average maturity of 10 years or more.

Best Index Funds for Short-Term Bonds

Short-term bonds are good choices for investors looking for low relative market risk with investment periods of less than three years. Short-term bonds also have lower interest rate risk, which means they can be smart investing ideas when interest rates are rising (bond prices typically move in the opposite direction of interest rates).

Vanguard Short-Term Bond Index (VBISX): The fund offers a diversified approach to bond investing, at low-cost, with broad exposure to U.S. investment-grade bonds with maturities from one to five years. It invests about 30 percent of assets in corporate bonds and 70 percent in U.S. government bonds within that maturity range.

Fidelity Short-Term Treasury Bond Index (FSBIX): The fund typically invests at least 80 percent of assets in securities included in the Bloomberg Barclays U.S. 1-5 Year Treasury Bond Index. It normally maintains a dollar-weighted average maturity of three years or less.

Best Index Funds for International Bonds

If you're looking to diversify your bond fund holdings beyond the U.S., a smart choice is to use an index fund that invests in foreign bonds.

Vanguard Total International Bond Index (VTIBX): This fund seeks to provide broad exposure to non-U.S. investment-grade bonds. It tracks the performance of an index that includes international government, agency, and corporate securities, mostly from developed countries, but some emerging markets countries can be found on it. As is typical, the fund is subject to interest rate risk. Increases in interest rates could cause the bond prices in the portfolio to decrease, reducing the fund’s net asset value.

Because it invests in non-U.S. bonds, the fund is also subject to country and regional risks. It utilizes currency hedging strategies to protect against uncertainty in future exchange rates, so investment returns would reflect the underlying performance of international bonds.

Best Index Funds for Alternative Bond Types

There are several niche categories of bonds but a few that are available as index funds and worthy of investor attention are tax-exempt bonds and Treasury inflation-protected securities (TIPS) funds.

Vanguard Tax-Exempt Bond Index (VTEBX): This index fund provides broad exposure to U.S. investment-grade municipal bonds. It invests in investment-grade municipal bonds of all maturities: short-, intermediate-, and long-term issues, and has a duration profile of five to eight years. The fund sets about to provide a sustainable level of current income that is exempt from federal personal income taxes. Investors in higher tax brackets tend to find it attractive. Changes in interest rates can affect the fund by resulting in lower bond prices when interest rates go up or an eventual decrease in income for the fund when rates are on the decline.

Fidelity Inflation-Protected Bond Index Fund (FSIQX): The fund normally invests at least 80 percent of assets in inflation-protected debt securities within the Bloomberg Barclays U.S. Treasury Inflation-Protected Securities (TIPS) Index (Series-L). The fund holds investments in derivatives, such as swaps (interest rate, total return, and credit default) and futures contracts, as well as forward-settling securities, to adjust the fund's risk exposure.

A Caution on Bond Index Funds Before Buying

Bond index funds are great diversification tools and they can beat actively-managed funds in the long run. However, since they're passively managed, the portfolio managers are not able to buy and sell the holdings at their discretion. When interest rates are rising, this can be a negative factor because an index fund manager is forced to hold bonds that may be falling in price more than similar funds that are actively managed.

With that, in 2010, many active bond fund managers started predicting a rise in interest rates, and a corresponding decline in bond prices. But they were mostly wrong. The decline didn't start until 2013 but then turned mostly positive through 2017. Bond index funds outperformed most active funds from 2014 through 2016.

The bottom line is that even professional money managers can't accurately and consistently predict what markets will do in advance. This is why index funds are often the best investment idea for most investors.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.