What Is a Total Bond Fund?
Let me explain what a total bond fund really is. It's essentially a mutual fund or exchange-traded fund that aims to mirror a broad bond index, holding a variety of securities across different maturities from both public and private sectors. The go-to benchmark here is often the Barclays Aggregate Bond Index, which includes Treasury bonds, corporate bonds, municipal bonds, and high-grade mortgage-backed securities.
Key Takeaways on Total Bond Funds
You should know that a total bond fund tracks its underlying index, which reflects the entire bond market. By investing in one, you get the same market exposure as traditional bond holdings, but with much better liquidity in a sector that's usually hard to trade. These funds must maintain a similar maturity profile to the bonds in their index to function properly. One standout example is the Vanguard Total Bond Market Index Fund, which is quite popular among investors.
How a Total Bond Fund Works
Here's how these funds operate: they might invest in bonds that match the maturity, class, and rating of unavailable issues due to the bond market's diversity and lower liquidity compared to stocks. It's crucial for the fund to align its interest rate sensitivity and maturity with the base index.
Unlike total stock funds, total bond funds have more leeway in selecting securities. Since individual bonds aren't as liquid as stocks, managers sometimes skip certain index bonds and pick alternatives not in the index.
Many of these funds allocate about 20% of assets for manager discretion, allowing investments in things like international bonds, derivatives, or lower-rated corporate bonds. This gives them room to add noncorrelated assets while keeping the fund's risk similar to the Barclays Index.
Focus on key risks: the weighted average maturity and duration, which measure sensitivity to interest rate changes, need to stay close to the index.
Vanguard Total Bond Market Index
Take the Vanguard Total Bond Market Index as a prime example—it's built to give broad exposure to U.S. investment-grade bonds. It puts about 30% in corporate bonds and 70% in U.S. government bonds across all maturities, from short- to long-term. As of June 2022, its 10-year annualized return was 1.34%.
Like other bond funds, it faces risks from rising interest rates, which can drop bond prices and lower the fund's NAV. Since it covers all parts of the fixed income market, you might use it as your main bond investment.
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