Bond ETFs: Keep the Expenses Low - dummies

By Russell Wild

Low costs are even more essential in picking a bond ETF than they are in picking a stock ETF. When (historically, at least over the past century) you’re looking at maybe earning 2.4 percent above inflation, paying a manager even 1.2 percent a year is going to cut your profits in half . . . more than half if you are paying taxes on the bond dividends. Do you really care to do that?

Right now, interest rates are very low, which means that real interest rates (factoring in inflation) for most bonds are considerably less than 2.4 percent. That fact means paying attention to the cost of your bond funds is more essential than ever.

The most economical bond funds are index funds, and you have a number of excellent index bond mutual funds to choose from.

The ETF edge in the fixed income arena isn’t nearly as sharp as it is in stocks. The tax efficiency of a bond index mutual fund and a bond ETF are just about the same. The wonderful structure of ETFs simply doesn’t matter much when it comes to bonds.

Bonds pay interest — that’s how you make money with bonds — and they rarely see any substantial capital gains. To the extent that they do have capital gains, however, ETFs may have an edge over mutual funds. But that’s generally not going to be any big deal.