Problems with Total Bond Market Index funds | Investor in a white coat (2023)

Bydr James M. Dahle, Founder of WCI

"Hate" may be too strong a word, even if it made you click on this article. I don't hate Whole Bond Index Funds and ETFs (TBMs). It may even be a reasonable element, solid investment portfolio. It's just not my preferred title option. While the stock index fund is minefavorite mutual fundand includes an international exchange-traded index fundpart of my portfolio, it's a bit weird that I don't like the third member "portfolio of three funds"triumwirat".

But I think I have good reasons for that. Want to know what they are? Read on.

What is Total Bond Market Fund?

First, let's define what TBM is. We will useVanguard version (BND)as our example, although there are several other good (and almost equivalent) TBMs/ETFs out there. This discussion applies to all of them. As of May 1, 2022, TBM is a fund that has a representative selection of the vast majority of US-issued securities by market capitalization and includes:

  • 47% Treasures
  • 27% of the company
  • 22% of mortgage-backed securities
  • 4% Other

There are over 10,000 securities in the portfolio. It has an effective maturity of 8.9 years and an average duration of 6.6 years, with more than two-thirds of the fund made up of US government bonds (67.5% US government, 3.6% AAA, 2.9% AA, 12% are A and 14% are BBB). It has a coupon of 2.9% and a current yield to maturity of 4.3%. It is available in Vanguard, Fidelity, Schwab and iShares versions – and in traditional versions of mutual funds and ETFs.

Problemy z Total Bond Market Fund

Now that we've defined the background, let's talk about why I don't use it.

#1 TBM is not total

For something that claims to have "everything", there are a huge number of titles that are not included in the fund. Here are some of the omissions:

  • EE savings bonds
  • I Savings Bonds
  • END
  • Junk bonds (high yield)
  • City titles
  • Foreign Securities
  • Private titles

It's just a "one stop shop" if you don't want any of those other things. Imagine a total exchange-traded fund omitted REITs, tech stocks, and health stocks. You wouldn't consider that too "total", would you? You don't have to invest in everything, but if you're going to say yes, you really should.

More information here:

Which bond fund should you keep?

#2 No protection against inflation

The main opponent of my wallet isinflation. Although inflation has been low for most of my investing career, I know that in the long run, inflation is the most devastating hidden risk that can block my path to my financial goals. I built the wallet from scratch to best withstand inflation. Many stocks, real estate and even bonds are well positioned to withstand inflation. Now that the risk of inflation has actually arrived, people think about it much more often. Inflation protection is nothing new to me and is one of the reasons why I don't like TBM.

TBM is highly vulnerable to inflation. Even though interest rates have increased in recent months, you still lose money to inflation with TBM.

So how does long-term asset allocation in my bond portfolio help protect me from inflation? Two main things:

  1. Put half of my bonds in inflation linked bonds like TIPS and I Bonds, neither of which are on TBM.
  2. Keep durations short to minimize losses due to rising interest rates and quickly allow the portfolio to start generating higher returns as interest rates rise.

TBM does neither of those things. While bond funds may perform even worse in an inflationary environment, TBM is quite poor.

#3 He takes risks on the cover side

I prefer to take risk on the capital side, where it is more effective (not only from a tax perspective). When the company is not doing well, the bonds are worth less due to the risk of the company going bankrupt. This risk does not occur with higher quality bonds, which are less likely to default. If you're going to bankrupt companies, I want to make more money for it. You do this by owning the business, not by lending it money. I do not take corporate risk with my bond portfolio. I only lend money to governments that have the right to tax - be it the federal government (G Fund, TIPS, I Bonds) or state and local governments (muni bonds). So I carry stocks to get my equity risk.

If I really want to take the risk of fixed income, I prefer to do it with fixed incomeprivate real estate debt fundsand earn 7%-11%, not just the 4%-5% (and 2% a year ago) that TBM can give you. The purpose of the bonds in my portfolio is security, so I keep my bonds safe. Relatively low interest rate risk (none with I bonds and G fund) and very low default risk.

More information here:

That's why I don't have bonds in my portfolio

#4 own mortgage bonds

Problems with Total Bond Market Index funds | Investor in a white coat (4)

Mortgage bonds seem more attractive than treasury and corporate bonds because they offer higher yields. However, there are certain risks inherent in mortgage securities. If interest rates fall, mortgage holders will refinance and you will have to trade your bonds for lower yield bonds. They do not appreciate as much as other bonds when interest rates fall. When rates go up, nobody refinances (or even moves), but you're still stuck earning low profits. Only in an environment of very stable interest rates do you come out ahead. We never seem to be in a stable interest rate environment. So why add this risk to your portfolio when it is so easy to skip it?

#5 Wrong and taxable

For everyone at the highest leveltax thresholdswho have to hold a significant portion of their securities in a taxable account (i.e. people like me), TBM is not optimal. Less than half of the fund is treasury bonds (which are exempt from state and local taxes). Unlike muni bonds, all interest is fully taxable at normal income tax rates. As I write this post, TBM and Vanguard Tax-Exempt ETF (VTEB) have somewhat similar durations (6.6 and 5.5) and efficiency (4.3% to 3.2%). If I adjust that 4.3% to my 37% tax bracket, it's actually less than 3.0%. Why would I take less than 3.0% when I can get more than 4.0% with less term risk (shorter duration) and less risk of default? I'm not.

More information here:

If you want more money, you should hope that 2023 will be similar to 2022

Maybe you like TBM. This is good. Like I said, it's a good bond fund and can be a very decent part of your portfolio. There are many roads to Dublin. But it's not in my portfolio and probably never will be.

Do you need your own financial plan? CheckFire your financial advisercourse! It's a step-by-step guide to creating your own path to financial freedom. Try it risk free today!

What do you think? Are you investing in TBM? Why or why not? How else do you invest in bonds? Comment below!


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