Bond index funds


N

nonsense

I had posted earlier asking for the next riskier investment after Bank
CD's. It was suggested I buy Vanguard's Total Bond Market Index
(VBMFX) fund. I have my IRA account with Fidelity and notice they
charge a $75 fee. However, there is also Fidelity U.S. Bond Index Fund
(FBIDX) which has no fee. Is there much difference between the two? I
am looking to invest around $16k .

I assume that all taxes are deferred since I have a SEP-IRA. Are there
any special things I should be aware of when investing in bond index
funds?
 
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P

ps56k

I had posted earlier asking for the next riskier investment after Bank
CD's. It was suggested I buy Vanguard's Total Bond Market Index
(VBMFX) fund. I have my IRA account with Fidelity and notice they
charge a $75 fee. However, there is also Fidelity U.S. Bond Index Fund
(FBIDX) which has no fee. Is there much difference between the two? I
am looking to invest around $16k .

I assume that all taxes are deferred since I have a SEP-IRA. Are there
any special things I should be aware of when investing in bond index
funds?
when you "go outside" of a fund company,
they charge you a fee....

If you want that specific fund - you can just setup another IRA account with
Vanguard.
 
M

Mark Freeland

It was suggested I buy Vanguard's Total Bond Market Index
(VBMFX) fund. I have my IRA account with Fidelity and notice they
charge a $75 fee. However, there is also Fidelity U.S. Bond Index Fund
(FBIDX) which has no fee. Is there much difference between the two? I
am looking to invest around $16k .
There are portfolio differences, but not substantial. They use their own
sampling techniques, but their goals are the same - to track Barclay's US
Aggregate Index.

More significant is the cost. VBMFX at 0.22% costs less than half of what
FBIDX costs - 0.48%. That difference, 0.26%, over the course of two years,
will cost more than the $75 transaction fee you're facing. As far as
additional purchases are concerned, you can make them at Fidelity for
$5/purchase if you tell their system you are making automatic periodic
payments - you only have to do this for one "period", i.e. a single purchase
at a time.

But you can do even better with the Vanguard fund, by purchasing a cheaper
share class of the same fund. Instead of using the Investor Class shares
(VBMFX), use the ETF class shares (BND). You'll pay a stock commission
(about $11/trade), but you'll be getting shares with even lower expenses
(0.14%). If you hold those shares for just 3 months, you'll come out ahead.

Fidelity will reinvest dividends of either share class with no charge.
I assume that all taxes are deferred since I have a SEP-IRA. Are there
any special things I should be aware of when investing in bond index
funds?
Personally, at least for bond index funds, I prefer intermediate term funds
over total market - it seems that the marginally higher interest on long
term bonds doesn't merit the extra risk (credit risk, interest rate risk)
that one is taking with the longer maturities. And the short term bonds
that they hold are more suitable for a short term investing horizon. (I
feel differently about actively managed bond funds, because there, the
manager has the flexibility to eschew the short term bonds and to adjust
maturity/duration as the yield curve shifts.)

Otherwise, just buy the cheapest bond index fund - cheapest meaning total
cost of ownership, including expenses, transaction costs, other fees.

Mark Freeland
(e-mail address removed)
 
B

BreadWithSpam

I had posted earlier asking for the next riskier investment after Bank
CD's. It was suggested I buy Vanguard's Total Bond Market Index
(VBMFX) fund. I have my IRA account with Fidelity and notice they
charge a $75 fee. However, there is also Fidelity U.S. Bond Index Fund
(FBIDX) which has no fee. Is there much difference between the two? I
am looking to invest around $16k .
Vanguard has tracked their benchmark a little (tiny) bit better
and has a lower expense ratio (0.20 vs. 0.32). They both track
the same underlying index.

You also have access to Vanguard's ETF version through you
fidelity account for a much lower transaction cost. The
symbol is BND and it's the same fund. Barclay's iShares ETF has
their version of the same one, too, AGG. The ETF versions
have even lower expenses (0.10 and 0.20 respectively).
 
N

nonsense

You also have access to Vanguard's ETF version through your fidelity account for a much lower
transaction cost. The symbol is BND and it's the same fund.
Thanks, I went and bought the Vanguard BND ETF. Fidelity charged $20
commission . I am curious what is the difference between this and the
Vanguard Bond Index Fund which has a $75 fee?
 
A

Andrew Koenig

Thanks, I went and bought the Vanguard BND ETF. Fidelity charged $20
commission . I am curious what is the difference between this and the
Vanguard Bond Index Fund which has a $75 fee?
One is a mutual fund; the other is an ETF.

Usually you can buy shares in a mutual fund only from the company that
issues the fund. The company determines the price, usually daily at the
close of business; if you buy or sell shares in the fund, you do so at the
next price determination point that occurs after your purchase.

Some companies charge commissions, which are sometimes substantial, to buy
(or sell) their shares. Vanguard does not. (They do charge purchase and
sales fees on some of their funds to discourage frequent trading, but those
fees go into the fund's assets rather than going to the company itself. I
do not believe that their bond index fund charges such fees)

Usually you can buy shares in an ETF only from another shareholder of that
ETF. The price of those ETF shares are therefore set by mutual agreement,
in exactly the same way as buying shares of an individual stock. This
characteristic means that it is possible for the price of ETF shares to
deviate from what the price would be for an equivalent set of shares of the
securities that constitute the ETF. To prevent this deviation from becoming
too large, the company that issues ETF shares normally offers to exchange a
sufficiently large number of ETF shares for a corresponding number of shares
in the underlying securities. So the way ETF shares get into the market in
the first place is that a company will collect a whole bunch of bonds, for
example, and hand those bonds over to Vanguard (along with an exchange fee)
in exchange for an appropriate number of shares of the ETF (in the case of
Vanguard, I think it's a multiple of 10,000 shares). That company will then
sell the ETF shares on the open market in exactly the same way as shares of
stock.

So if you want to buy shares of the Vanguard bond mutual fund through
Fidelity, Fidelity has to buy them from Vanguard. They charge you for this
service, partly to compensate them for their time and trouble, and partly to
discourage you from dealing with their competitor, Vanguard.

If you want to buy shares of the Vanguard bond ETF, you buy them through a
brokerage account in exactly the same way as you would buy shares of stock,
and the commission should be the same. However, you would also pay the
bid-ask spread, which comes from the fact that seller can never sell
something for a higher price than a buyer is willing to pay, but might sell
it for less, as well as the difference between the ETF price and the price
derived from the underlying securities -- a difference that might be
positive or negative.

You could have avoided the $75 fee by buying the mutual fund shares directly
from Vanguard. You can avoid the $20 fee for the ETF only by finding a
broker who charges less than $20 for that transaction.
 
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M

Mark Freeland

BND and VBMFX are two different share classes of the same mutual fund
(Vanguard Total Bond Market Index) - that means that either way, you own a
portion of the same underlying portfolio. Just as VBMFX - investor shares,
and VBTLX - admiral shares, are shares of the same portfolio.

This is different from, say, Fidelity's NASDAQ index fund, FNCMX, and
Fidelity's NASDAQ index ETF (ONEQ). While both of those funds track the
same index, they own different portfolios, with different tracking errors
(e.g. one holds 1971 stocks, the other 2110). There is no connection
between the two (other than tracking the same index, being managed by Geode
Capital, and marketed by Fidelity).

What differs between the Vanguard share classes BND and VBMFX, as Andrew
explained, is the way the shares are priced and sold. The traditional
mutual mutual fund share classes (VBMFX and VBTLX) are bought and sold at
NAV, while the ETF share class BND is bought and sold on the open market
(via brokers), and will have a bid/ask spread, and continuous pricing during
the trading day.

Mark Freeland
(e-mail address removed)
 
B

BreadWithSpam

Thanks, I went and bought the Vanguard BND ETF. Fidelity charged $20
commission . I am curious what is the difference between this and the
Vanguard Bond Index Fund which has a $75 fee?
A couple of others have commented, but I'll do what I can,
perhaps more than you're asking for:

There are basically three types of mutual funds (in terms of
how one buys or sells them): Open ended funds, closed ended
funds and ETFs. The mechanics of how the shares in those
funds are created/destroyed and how one buys those shares all
differ.

An open-ended fund (which is what most folks mean when they
just say "mutual fund" without being more specific) is managed
such that new shares are created or destroyed at the end of
each trading day. When you buy shares in an open-ended fund,
the fund company goes and figures out at the end of the day
just what each share is worth (NAV) and then takes your cash
and issues you new shares based on that value. Similarly,
when you sell out of one of thse, the same thing happens -
they figure out how much each share is worth, give you your
cash and the shares cease to exist. This is done by the
fund company itself and it works the same whether you buy
the shares directly from the company or if you buy them in
a brokerage account through which the same transaction takes
place.

So here's the thing about buying regular Vanguard open-ended
fund shares - if you buy them directly from Vanguard, there is
no fee - no commission, no transaction cost, nothing. But
if you buy them within a brokerage account (like, say, at
Fidelity), since Vanguard doesn't pay Fidelity anything to
facilitate those transactions, Fidelity will charge you a
transaction fee. In this case, $75 per purchase but they
don't charge you for sales. Fidelity has many funds
available which they call "NTF" - no-transaction-fee - funds.
They don't charge a fee to you for buying or selling, but
they do get paid by the fund companies for making the funds
available that way to you. Vanguard (and a few other companies)
won't pay the brokerages, so their funds are not NTF.

Now, ETFs are generally *not* bought or sold directly between
the individual and the fund company. Instead, ETF shares
trade on regular stock exchanges just like normal stock. When
you buy ETF shares, you may be buying them directly from another
individual. Or, you may be buying them from a third-party
financial institution which bought them from the fund company
itself. That third party company is called an "authorized
participant" and what happens is that if you buy your shares
from the authorized participant rather than from some other
individual who happened to already own them, the authorized
participant goes and creates the shares of the ETF in
a deal with the ETF sponsor. (The mechanics aren't quite
that important here).

Since you don't buy ETF shares from the fund company but
rather from a third party, and those shares trade between
you and that third party on regular stock exchanges, when
you buy or sell them, you pay your brokerage's regular
stock transaction commission.

Anyway, that's generally the difference, and why you paid
a $20 commission rather than zero or a $75 fee. Note that
you'll also pay $20 (or whatever you commission rate is)
to sell those shares eventually. You would not have such
a commission to sell the open-ended shares because of the
way Fidelity prices this service. Other brokerages do
charge for both purchases and sales of non-NTF funds.

When I said "it's the same fund" by the way, that's
specific to the Vanguard open-ended funds and their
corresponding ETFs. Most ETFs are entities unto themselves
but Vanguard's is a little different - theirs are a
separate share class of the same fund. In Vanguard's
case you are getting *exactly* the same underlying
portfolio. If you'd bought, say, iShares Barclays
Aggregate Fund (AGG), you'd also have been buying an
index fund which tracks the same Barclays (formerly Lehman)
Aggregate. But it's an entirely separate fund and
portfolio and there is no open-ended fund share class.
Vanguard is the only company which has ETFs and open
ended shares of the same fund rather than just similar
funds.

(I mentioned closed-end funds - they are a different beast
from either of the above, but FWIW, they are generally
bought and sold on the stock exchanges more like ETFs than
like open-ended funds)
 
A

Andrew Koenig

BND and VBMFX are two different share classes of the same mutual fund
(Vanguard Total Bond Market Index) - that means that either way, you own a
portion of the same underlying portfolio. Just as VBMFX - investor
shares, and VBTLX - admiral shares, are shares of the same portfolio.
This is different from, say, Fidelity's NASDAQ index fund, FNCMX, and
Fidelity's NASDAQ index ETF (ONEQ).
I believe, and your comment tends to confirm, that Vanguard's funds have a
different relationship to their ETFs than do other companies' funds. In
particular, I know that if you have shares of a traditional Vanguard fund,
Vanguard is willing to convert those shares to ETF shares for a nominal fee,
and that the conversion is not a taxable transaction. I also remember
hearing somewhere that Vanguard has a patent on this process.

One implication of this connection that I have also heard is that some
Vanguard mutual funds own shares of the corresponding ETF rather than owning
the underlying securities directly. I don't see that this should make any
difference to the retail investor, but I find such details interesting.
 
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M

Mark Freeland

I believe, and your comment tends to confirm, that Vanguard's funds have a
different relationship to their ETFs than do other companies' funds. In
particular, I know that if you have shares of a traditional Vanguard fund,
Vanguard is willing to convert those shares to ETF shares for a nominal
fee, and that the conversion is not a taxable transaction. I also
remember hearing somewhere that Vanguard has a patent on this process.
Their first patent is #6,879,964. You can find the patents by going to
http://patft.uspto.gov/netahtml/PTO/search-bool.html and entering Vanguard
and ETF as the search terms.

The first two seems similar (only skimmed briefly and represent the
patent(s) you are referring to), the third is entitled "Basket creation
process for actively managed ETF that does not reveal all of the underlying
fund securities" (so much for the claimed total transparency of ETFs).
Fourth appears to be a patent on how to price those non-transparent ETFs.
One implication of this connection that I have also heard is that some
Vanguard mutual funds own shares of the corresponding ETF rather than
owning the underlying securities directly. I don't see that this should
make any difference to the retail investor, but I find such details
interesting.
I don't see how this would work, given that the mutual fund share class and
the ETF share class are just shares in the same investment company. The
investment company does owns shares of various companies, and could in
theory own shares of itself, but usually when a company buys shares of
itself, those shares become "treasury shares" (no longer outstanding
shares). The situation you're describing is a bit different in this
respect, and thinking about the recursion is giving me a bit of a headache
:)

Mark Freeland
(e-mail address removed)
 

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