Unfortunately, when most retail investors invest in fixed income, they invest in bond funds and bond ETFs, which have poor investment returns. The
Vanguard Total Bond Market Index Fund, is an example of a large bond fund with poor returns.
Vanguard Total Bond Market Index Fund has a variety of classes and ticker symbols and, as of December 31, 2018, was the world's largest bond fund with
$204 billion under management.
The below table shows the five different share classes of the Vanguard Total Bond Market Index Fund, the size of each class, and its respective ticker
Dollars in billions
|Vanguard Total Bond Market Index Fund Investor Shares
|Vanguard Total Bond Market Index Fund Admiral Shares
|Vanguard Total Bond Market ETF
|Vanguard Total Bond Market Index Fund Institutional Shares
|Vanguard Total Bond Market Index Fund Institutional Plus Shares
|Vanguard Total Bond Market Index Fund Institutional Select Shares
On this slide, you can see the meager investment returns bond funds provide. Vanguard Total Bond Market achieved a total return of 0.3% in 2015,
2.5% in 2016, and 3.1% year to date (9/30/17). There are many reasons for the weak investment returns, but three factors drive this underperformance:
Since this Vanguard bond fund it so big, it owns over 8,000 bonds. While there are many bonds worth
owning, there are not 8,000. There's no reason investors need exposure to 8,000 bonds when owning a fixed income portfolio. Bonds typically
have lower risk and price volatility vs. stocks, so the overdiversification bond funds provide is not necessary for bond investors. Within the Vanguard
portfolio are some perfectly good bonds; however, the good ones get drowned out by thousands of other bonds that dilute the returns of the fund.
2) Low-yielding asset classes often highly sensitive to interest rates:
VBTLX is dominated by bonds that are the most sensitive to fluctuations
in interest rates: US Treasurys and mortgage-backed securities. These bonds are known as a 'rates' investments, with bond prices going up and down
based on what happens to interest rates. In addition, due to their perceived lower credit risk than corporate bonds, bonds such as US Treasurys pay
investors a lower coupon than a corporate bond with a similar maturity.
3) High hidden fees:
Investors have been misled by the mutual fund industry, which claims 'low-cost' index funds such as Vanguard Total
Bond Market Index Fund are truly low cost. As shown in our fixed income investing blog
Vanguard and other bond funds are anything but low cost, as these bond funds rapidly turn over their portfolio and incur significant trading costs.
The extent of these costs are not disclosed by the fund and are not included in a bond fund's expense ratio, a number that is vastly understated and misrepresents
the true costs of bond fund investing.
Many investors believe a bond's yield is the only return on which an investor should focus. We have shown how owning a select portfolio of individual
corporate bonds can enable investors to achieve returns that are higher than a bond's yield to maturity.