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On the surface, it can be hard to distinguish one total bond market index fund from another.
For instance, five of the funds on our list, all except VBTLX and the sustainable-investing option, primarily track the Bloomberg U.S. Aggregate Bond Index. That’s no accident, since it’s widely considered the main benchmark for the U.S. bond market, covering all major types of fixed income.
A total bond-market fund aims to provide investors with access to a cross-section of the entire investment-grade U.S. bond market in one fund. This streamlines investing and ensures broad representation of the high-credit fixed income universe.
It’s crucial for shareholders to understand that the price of an individual bond or fund will change based on movements in market interest rates. When market interest rates rise, the value of the bond or fund will drop. Older, lower-yielding bonds are replaced with new, higher-yielding bonds. And when interest rates decline, the value of a bond fund rises while the yield on new bonds fall.
For those reasons, it’s important to understand a total bond market index fund’s place in your portfolio. It’s best to own them for the long term, five years or more. That helps you weather short-term volatility.
Average Duration and TIPS
There are at least two important considerations beyond performance that fund shareholders should keep in mind.
First, the duration of the funds in our list hovers around six years. Duration helps us understand how much the value of a fund will rise or fall with interest rates. Generally, for each 1% rise or fall in interest rates, a fund’s value will move in the opposite direction by a percentage equal to its duration.
Given the historically low interest rate environment and the recent rise in yields, you need to consider the interest rate risk associated with a total bond index fund.
Second, the Bloomberg Agg bond index and other key benchmark indexes are limited to fixed-rate securities. As a result, the index and the funds that track it do not invest in Treasury Inflation Protected Securities (TIPS), which protect investors from rising inflation.
TIPS are an important part of a well diversified portfolio—for investors wanting exposure to TIPS, they’ll need to consider other bond funds.