How to Find Fabulously Frugal Funds

By Russell Wild

Regardless of which way you decide to invest your money, bond funds or individual bonds, the going is easier and potentially more lucrative today than it was just several years ago. And it’s getting easier all the time.

Expensive bond funds still exist. According to Morningstar Principia, at least 180 of them charge 2 percent or more in annual fees. Imagine. At today’s modest interest rates, most bonds yield less than 4 percent a year; the majority are yielding closer to 3 percent. That’s a nominal — before inflation — 3 percent a year. After inflation, you’re looking at a total real return of about 0.5 to 2 percent a year. After taxes, you’re looking at less than that. And you’re going to fork over 2 percent to a fund manager? Lots of people do!

But paying such high fees, once a hard thing to avoid, is now strictly optional. Yes, the times they are a changin’. In 1998, 36 bond funds had expense ratios of 0.50 percent or below. That number is now over 800. In the past few years, you’ve seen a virtual revolution in the world of investment funds. Many of the bond funds now recommended have annual fees of 0.20 percent or less — a decade or so ago, that was unheard of.

The lowering of fees is largely due to the recent introduction of exchange-traded funds (ETFs). ETFs are wonderful investment vehicles in their own right — both inexpensive and tax-efficient. They have also given some serious competition to mutual funds, resulting in a lowering of fees across the board.

A lineup of ETFs from Vanguard, State Street SPDRs, BlackRock’s iShares, Schwab, and PIMCO, all of which allow anyone with minimal money to buy, allows you to invest in numerous bond index funds — Treasury or corporate, short-term or long-term — for annual fees of a mere 0.05 to 0.20 percent. A number of bond index mutual funds from Vanguard and Fidelity — the two largest U.S. financial supermarkets — are charging annual fees in the same ballpark (although most of these mutual funds have minimums of at least $2,500).