Q&A: Stay in Bonds?

Q:

My work place 403b plan has only 3 bond fund options: Vanguard Total Bond Market Index (VBTLX), Prudential Total Return Bond Z (PDBZX) and Metropolitan West Total Return Bond I (MWTIX).

I would like to keep bonds in my 403b because of tax efficiency. Is this a wise thing to do given the options?

A:

You have one good option and one great one. Even better news is the fact that the "great" option, Vanguard Total Bond Market Index is the only bond fund you will ever need in your 401k.

While higher yielding, the Prudential fund (PDBZX) has the highest expenses of the bunch at 0.72% per year. The fund also takes the most risk (and risk is why you stocks) with 1300 bonds in the portfolio, only 40% of which are AAA rated.

Metropolitan West's (MWTIX) offers a few more bonds (1400), a lower fee (0.40%), and better quality (70% AAA rated).

Vanguard's Total Bond fund (VBTLX) beats the lot. When owning lower-yielding, high quality bonds (70% AAA rated) fees really matter. VBTLX only charges 0.08% per year and this means a slightly higher income to investors with the same level of risk. Another key to reducing volatility is diversification. Vanguard has more than 16,000 bonds in its portfolio.

I would be very comfortable with 100% of my portfolio's bond allocation in Vanguard Total Bond Market Index Fund.