Bond ETFs vs. Bond Mutual Funds

If you want to put some of your money into bond funds, you have a choice between mutual funds or exchange-traded funds (ETFs). While the two options are alike in that they can provide you with diverse exposure to various sectors of the bond market, there are a few key differences you should know.

Method of Purchase

There is a slight difference in the way you can purchase mutual funds compared with ETFs. Mutual funds are often bought through the issuing company or a financial advisor, but you can also get them through brokerage accounts.

While many funds have no load or up-front purchase charge, an investor who does pay this sales charge may have a hard time keeping up with the earnings of ETFs once this fee is factored into their returns.

ETFs don’t have loads, which is a plus, but they do have transaction charges, since they are bought and sold just like stocks. The investor must set up a brokerage account, which they wouldn’t always have to do in order to buy a mutual fund.

You should factor in all of these expenses when you are thinking about the costs and benefits of mutual funds versus ETFs.

Costs

Costs are the main contrast between mutual funds and ETFs. In 2020, the average bond mutual fund had an annual expense ratio of 0.42%, while the average index bond ETF had an expense ratio of 0.13%. A difference of 29 basis points may not sound like much, but over time it can have a big impact on returns, due to the compounding effect that the added cost has on performance year after year.

Higher fees are a real concern with bond funds, where expected yearly returns are modest, and 0.29 basis points can take a large bite out of your gain. That is something to think about even more now, given the ultra-low yields on things accounts savings and money market accounts.

Performance

The table below compares returns of bond funds and bond ETFs within specific categories over the three- and five-year periods ending July 15, 2021.

Keep in mind that in some cases, the returns are skewed by the small sample size in a given category during the five-year period. For instance, there were few ultrashort-term bond ETFs, which helps explain the large change in performance in that category.

Mutual fund data is sourced from Morningstar's category returns page. ETF returns come from the ETF center at Yahoo! Finance.

The performance advantage favors mutual funds, which you may not expect, given the rapid growth of ETF assets in recent years. A larger amount of mutual funds are actively managed, compared to ETFs, so their modest outperformance shows that investors are getting value for the higher costs and fees.

Another good thing about mutual funds is that their prices don't become removed from the value of the securities in the portfolio during periods of market stress, which can occur with ETFs.

Be sure to weigh all points with care when you're deciding where to put your money. They include tax issues, fees, and the long-term results of the funds you’re thinking of buying.