Best Index Funds for Bonds

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

••• We found the best bond index funds at Vanguard and Fidelity. Getty Images

When you think of the best index funds, the first thought that comes to mind probably won't be bonds. But the same advantages index funds offer for stock mutual funds extend to bond mutual funds as well.

In fact, some of the benefits of index investing can be more significant with bond funds than with their stock fund cousins. For example, many bond investors looking for income will naturally want to squeeze as much yield out of their bond funds as possible and the low expenses inherent with index funds definitely help in that effort.

Another assumption many investors understandably make, that isn't exactly true, is that all the best index funds can only be found at Vanguard Investments. While Vanguard is no doubt the king of low-cost investing, and many of the best bond index funds are in the Vanguard lineup, there's still a handful of outstanding choices at other fund companies, primarily from Vanguard rival Fidelity Investments.

So with that backdrop, we'll share the best bond index funds in different categories, which will hit 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 8,500 bonds. To do this VBMFX tracks the Barclay's US Aggregate Bond Index. The expense ratio for VBMFX is a rock-bottom 0.16 percent and the minimum initial investment is $3,000.
  • Fidelity Total Bond (FTBFX): Although Fidelity's Total Bond fund has a slightly higher expense ratio (0.45 percent) than VBMFX, the added expense can be worth it because FTBFX has historically put up higher annualized returns and yields. The fund does this by concentrating its holdings (about 1,300 compared to 8,500-plus for VBMFX) into bonds in the Barclay's Aggregate that can produce higher gains and yields. This makes it a bit riskier than some bond index funds but still a high quality choice with potential for greater gains in the long run. The minimum initial investment for FTBFX is $2,500.

    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, you won't find a finer choice than VBLTX. The fund tracks the Bloomberg Barclays U.S. Long Government/Credit Float Adjusted Index, which includes over 2,000 bonds, consisting of about 60 percent corporate long-term bonds and 40 percent long-term US Treasury bonds. The expense ratio is low at 0.16 percent and the minimum initial investment is $3,000.
    • Fidelity Long-Term Treasury Bond Index (FLBIX): If you're looking for high exposure to long-term U.S. Treasury bonds, FLBIX is one of the best index funds to do the job. The fund normally invests at least 80 percent of its assets in the Barclays Long Year U.S. Treasury Index. The holdings are more concentrated and are normally around 50 bonds. The expense ratio is low at 0.20 percent and the minimum initial investment is $2,500.

      Best Index Funds for Short-Term Bonds

      Short-term bonds are good choices for investors looking for low relative market risk with investment periods 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 opposite direction of interest rates).

      • Vanguard Short-Term Bond Index (VBISX): If you're looking for low-cost exposure to a broad selection of short-term bonds, VBISX is one of the best bond funds for your money. The portfolio consists of approximately 30 percent corporate bonds and 70 percent U.S. government bonds. This mix provides a balance of risk and safety which can produce yields better than similar funds that invest 10 percent of assets in government bonds. The expense ratio for VBISX is 0.16 percent and the minimum initial investment is $3,000.
      • Fidelity Short-Term Treasury Bond Index (FSBIX): As the name suggests, FSBIX focuses on U.S. Treasury bonds. The portfolio concentrates holdings up to 80 percent of assets. Treasury bonds typically have lower yields than corporate bonds but the market risk is lower. Therefore, if you are looking for relative safety of principal in a short-term holding period, FSBIX can be a smart choice. The expense ratio is 0.19 percent and the minimum investment is $2,500.

      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): For investors wanting to diversify into foreign bonds with an index fund, there's really only one good choice and this fund from Vanguard is it. VTIBX seeks to track the performance of an index that includes different types of bonds, from foreign government and agency bonds and corporate bonds, mostly from developed countries, but also from some of the lesser developed emerging markets countries. The expense ratio is rock bottom at 0.17 percent and the minimum initial purchase is $3,000.

        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 and Fidelity have more outstanding choices here:

        • Vanguard Tax-Exempt Bond Index (VTEBX): This bond index fund provides broad exposure to municipal bonds, which are exempt from tax at the federal income level. Some municipal bonds also offer tax-free income but they must be from states and municipalities where the purchasing investor lives. However limiting oneself to just one state also reduces potential for higher yields and better long-term returns. Therefore a diversified tax-exempt bond index fund like VTEBX can be a smart choice. The expense ratio is VTEBX is 0.25 percent and the minimum initial purchase is $3,000.
        • Fidelity Inflation-Protected Bond Index Fund (FSIQX): Treasury inflation-protected securities (TIPS) bonds can work as a hedge against inflation and FSIQX is one of the best TIPS funds out there. The expense ratio is extremely low at 0.19 percent and the minimum initial purchase is $2,500.

        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 index fund manager is forced to hold bonds that may be falling in price more than similar funds that are actively managed.

        In different words, if bond prices are about to fall off of a cliff, the bond index fund manager is forced to go over the cliff, while the active manager can possibly avoid the worst of the fall.

        With that said, many active bond fund managers started predicting a rise in interest rates, and a corresponding decline in bond prices, as early as 2010. But they were mostly wrong. Bonds didn't turn negative 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.

        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.