Bond ETFs vs. Bond Mutual Funds

Historical Returns and Costs

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If you want to put some of your money into bond funds, you have a choice between mutual funds or exchange-traded funds (ETFs). While the two options are alike in that they can provide you with diverse exposure to various sectors of the bond market, there are a few key differences you should know.

Method of Purchase

There is a slight difference in the way you can purchase mutual funds compared with ETFs. Mutual funds are often bought through the issuing company or through a financial advisor, but you can also get them through brokerage accounts.

While many fund fees have no loads or up-front purchase charges, an investor who does pay this sales charge may have a hard time keeping up with the earnings of ETFs once this fee is factored into their returns.

ETFs don’t have loads, which is a plus, but they do have transaction charges since they are bought and sold just like stocks. This also requires the investor to set up a brokerage account, which they wouldn’t always have to do in order to buy a mutual fund.

You should factor all of these expenses when you are thinking about the costs and benefits of mutual funds versus ETFs.

Costs

Costs are the main contrast between mutual funds and ETFs. In 2020, the average bond mutual fund has an annual expense ratio of 0.42%, but the average bond ETF has an expense ratio of 0.13%. A difference of 29 basis points may not sound like much, but over time it can have a big impact on returns. This is due to the compounding effect the added cost has on performance year after year.

Higher fees are a real concern with bond funds, where expected yearly returns are modest and 0.29 points can take a large bite out of your gain. This is something to think about even more now given the ultra-low yields on things like savings and money market accounts.

Performance

The table below compares returns of bond funds and bond ETFs within specific categories over the three- and five-year periods ending July 15, 2021.

Keep in mind that in some cases the returns are skewed by the small sample size in a given category during the five-year period. For instance, there were few ultrashort-term bond ETFs, which helps explain the large change in performance in that category.

Mutual fund data is sourced from Morningstar's category returns page. ETF returns are from the ETF center at Yahoo! Finance.

Category 3-Year Return 5-Year Return
Ultrashort Term Bond (Mutual Funds) 1.95% 1.60%
Ultrashort Term Bond (ETFs) 0.95% 0.34%
Short-Term Bond (Mutual Funds) 2.43% 2.11%
Short-Term Bond (ETFs) 1.96% 2.68%
Intermediate-Term Bond (Mutual Funds) 3.73% 2.90%
Intermediate-Term Bond (ETFs) 3.38% 4.64%
Municipal National Short (Mutual Funds) 1.76% 1.53%
Municipal National Short (ETFs) 1.26% 1.65%
Municipal National Intermediate (Mutual Funds) 3.13% 3.11%
Municipal National Intermediate (ETFs) 4.37% 5.43%
Municipal National Long (Mutual Funds) 3.54% 3.70%
Municipal National Long (ETFs) 6.04% 6.25%
High Yield Muni (Mutual Funds) 3.34% 3.93%
High Yield Muni (ETFs) 7.45% 8.47%
Inflation Protected (Mutual Funds) 3.96% 2.98%
Inflation Protected (ETFs) 3.22% 5.43%
Corporate Bond (Mutual Funds) 5.03% 4.86%
Corporate Bond (ETFs) 6.18% 7.67%
High Yield (Mutual Funds) 2.24% 3.45%
High Yield (ETFs) 7.82% 11.90%
Bank Loan (Mutual Funds) 1.20% 2.04%
Bank Loan (ETFs) 4.95% n/a
World Bond (Mutual Funds) 2.31% 2.52%
World Bond (ETFs) 3.27% 3.61%
Emerging Market Bond (Mutual Funds) 1.76% 3.72%
Emerging Market Bond (ETFs) 3.10% 9.98%

The performance advantage favors mutual funds, which you may not expect given the rapid growth of ETF assets in recent years. A larger amount of mutual funds are actively managed compared to ETFs, so their modest outperformance shows that investors are getting value for the higher costs and fees.

Another good thing about mutual funds is that their prices don't become removed from the value of the securities in the portfolio during periods of market stress, which can occur with ETFs.

Be sure to weigh all points with care when you're deciding where to put your money. This includes tax issues, fees, and the long-term results of the funds you’re thinking of buying.