Vanguard Bond Funds

Vanguard Bond Funds: The Only 3 Bond Funds You Will Ever Need

Vanguard bond funds are an important part of any investor’s portfolio. However, there are so many to choose from that just looking through the list of available bond funds makes my head spin. So, which of these Vanguard bond funds should you choose?

The only three bond fund you will need to cover your bond exposure are BND, BNDX and BNDW. These index funds will give you all the bond exposure you need at minimal fees. BND provides exposure to the US bond market. BNDX diversifes your portfolio internationally. And BNDW comprises both domestic and international bonds.

Introduction

In this article, we will discuss Vanguard bond funds and how they can help mitigate the volatility of your stock portfolio. I have selected the top 3 bond funds by Vanguard that are best suited for this task

First I will go over what a bond fund is and how Vanguard bond funds work. We will also discuss why bond funds are an important part of every investor’s portfolio. We will then take a look at the three bond funds I have selected which are BND, BNDX, BNDW.

All of the funds that I have selected are exchange-traded funds (ETFs). These Vanguard bond ETFs provide the lowest expense ratio and are more tax-efficient than mutual funds.

What are Vanguard bond funds?

Vanguard bond funds are actually made up of a basket of individual bonds ranging from short to long-term maturities and corporate to government bonds. Each fund holds at least 1000 bond issuances that are held in separate LLCs.

As an investor in Vanguard’s bond funds, you essentially become a shareholder of that LLC and thanks to Vanguard’s unique structure you will also become a part-owner of the Vanguard Group.

Although Vanguard also offers bond funds in the form of mutual funds, I will focus mostly on ETFs that track a certain bond index and are passively managed.

Why bond funds are important

Bond funds are important in order to mitigate the volatility risk of a stock portfolio. On average, an allocation of 25 to 50% in bonds has resulted in a more stable growth of total portfolio value:

Portfolio Stocks/Bonds Allocations
Portfolio Stocks/Bonds Allocations

However, in terms of total returns, a 100% stock portfolio has clearly outperformed a mixed (stocks/bonds) portfolio. Hence, my point above, bonds are important to mitigate volatility.

Especially in times of economic decline bonds provide a valuable hedge against the loss of value of stocks. On the other hand, in times of economic boom and low-interest rates bonds tend to perform worse than stocks and can even hold back portfolio growth.

It is often said that your allocation to bonds should increase as you approach retirement but this approach fails to take into account the dynamic of market cycles. Varying a portfolio allocation between 25 to 50% in bonds and rebalancing at the right times can be much more advantageous than simply determining a bond allocation based on your age.

The Top 3 Vanguard Bond Funds

In the following section, I will go through the top 5 Vanguard Bond funds that can help you stabilize your portfolio, potentially increase returns and achieve financial freedom.

BND

The first Vanguard bond fund we will discuss is their Total Bond Market ETF (BND) which includes more than 9,000 securities in the form of short-term and long-term bonds. The index fund is comprised of corporate, municipal, and treasury bonds and aims at giving investors exposure to the entire market.

BND is comprised of 9,719 different corporate, municipal, and treasury bonds. Despite its large number of holdings, BND has an expense ratio of only 0.035%. The fund is composed mostly of AAA-rated bonds and has a compound annual growth rate (CAGR) of 4.31%.

BND - Portfolio Growth
BND – Portfolio Growth
PortfolioInitial BalanceFinal BalanceCAGR
BND$10,000$17,000 4.31% 
BND – Portfolio Backtest

This Vanguard fund is best for investors looking for broad exposure to the US bond market and provides a low-cost way of allocating a certain portfolio percentage to bonds.

One risk that BND poses is that it does not include any international bonds. Thus it is very US-centric and reliant on US corporations to back their debts. However, with global economies being as intertwined as they are, one could argue that international exposure is priced into the domestic bond market.

For a more detailed analysis of Vanguard’s Total Bond Market Fund make sure to check my complete BND review here.

BNDX

The Vanguard Total International Bond Fund (BNDX) is also an ETF and an index fund that tracks excludes bonds issued in the United States. It is heavily weighted towards European and Asia-Pacific bonds.

BNDX has had a compound annual growth rate (CAGR) of 4.51% over the last few years. As a result, a $10,000 portfolio invested entirely in BNDX would have resulted in a final balance of $13,416. In the given time frame international bond returns have outperformed domestic bond returns by 20 basis points.

BNDX - Portfolio Growth
BNDX – Portfolio Growth
PortfolioInitial BalanceFinal BalanceCAGR
BNDX$10,000$13,416 4.51%
BNDX – Portfolio Backtest

BNDX is great for investors who want to increase their exposure to bonds outside of the United States and want to do so so at a minimal cost. The obvious downside to this Vanguard bond fund is that it does not include United States bonds. The US is one of the biggest economies in the world and as such should not be missing from any bond portfolio.

Thus, BNDX can only be used as a supplemental bond fund for investors who already own BND or are otherwise exposed to US bonds.

A while back I have compared the two most important bond funds: BND vs. BNDX. Click here to read the full comparison.

BNDW

Vanguard’s Total World Bond ETF (BNDW) tracks a global index of corporate and government bonds. This includes international bonds as well as domestic ones.

Since BNDW is a fairly new fund the time frame we have to analyse the fund’s performance is very limited. During this period starting in January 2019 BNDW has exerienced a CAGR of nearly 8%. A phenomenal return in today’s bond markets. A $10,000 portfolio would have turned into $11,356 in less than 2 years.

BNDW - Portfolio Growth
BNDW – Portfolio Growth
PortfolioInitial BalanceFinal BalanceCAGR
BNDW$10,000$11,356 7.93%
BNDW – Portfolio Backtest

In a way, BNDW is the perfect combination of BND and BNDX. Much like Vanguard’s Total World Stock Fund (VT) is a combination of Vanguard’s Total Stock Market Fund (VTI) and Vanguard’s International Stock Market Fund (VXUS).

It is best suited for international investors looking for US bond exposure without neglecting international bonds. There are very few downsides associated with Vanguard’s Total World Bond Fund since it is by far the most diversified bond fund available.

The only disadvantage BNDW might have in contrast with BND is that US interest rate policy differs from most other central banks this way it can be difficult to achieve the same returns you would historically have achieved with a domestically focused stock and bond portfolio.

Through dynamic rebalancing, however, as emerging economies gain greater market share the size of the US economy in relation to global GDP becomes less significant. As a result, this bond index fund should set your portfolio up well for the future.

BNDW is a bond fund newly added to the family of Vanguard bond funds. It remains to be seen how the fund will perform compared to BND and BNDX although initial backtests look promising!

If you’d like to read more about the intricate differences of BNDW and BNDX click here to read my full comparison: BNDX vs. BNDX.

Conclusion

There is no shortage of bond funds on the market. Vanguard alone has several dozen to choose from. So, how to chose the right Vanguard bond fund for your portfolio?

In fact, you only really need to consider 3: BND, BNDX, and BNDW. These three funds make up the core of the bond market and can safely add bond exposure to your portfolio.

BND is the Vanguard bond fund for you if you live in the United States, are a domestically focused investor, and believe that global economies are connected in today’s world that further international exposure is just not necessary.

BNDX is the Vanguard bond fund for you if you already own US bonds and would like to increase your international exposure. It is not suited as a standalone bond fund since it excludes bonds from the world’s largest economy: the United States.

BNDW is the Vanguard bond fund for if you live outside the US, but still want to make use of Vanguard’s fantastic products and believe in global diversification. Of course, you can also own BNDW if you live in the US but most US investors already tend to be familiar with BND so just adding BNDX might be simpler.

And there you have it! The only 3 Vanguard bond funds you will ever need. Remember, more often than not, simplicity is the key to success.

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