When you buy a suit you expect to pay for better quality, but a new car selling at the full sticker price drives no better than one from a cut-rate buying service.
Bond funds are more like cars than suits - the cheaper the better. That's because they all tend to behave pretty much alike.Their managers count gains and losses in "basis points" - hundredths of a percentage point. In buying a bond fund you also should pay attention to such small differences in expense ratios.
Want proof? We lumped together all high-quality corporate, mortgage- and government-bond funds. Their average annual expense ratio is 0.95 percent.
Then the funds were divided into two groups - cheap funds (those with average or below-average expense ratios) and expensive funds (those with above-average expenses).
As a group, the cheap funds produced higher returns than the expensive funds over every time period - one, three, five, 10, 15 and 20 years.
Moreover, the cheap funds achieved their superior returns with less volatility, meaning their returns bounced around less from month to month than those of the expensive funds.
And cheap funds held bonds with shorter maturities, making them less vulnerable to increases in interest rates.
In 1994, for instance, when interest rates soared, the typical expensive fund lost 4.1 percent, while its less-costly counterpart fell only 2.6 percent.
Cheap's the word in other portions of the bond market, too. On average, cheap tax-free bond funds deliver better total returns with less risk than do high-expense muni funds.
And cheap high-yield (junk-bond) funds - those with expenses
of 1.35 percent or less - tend to do better than their high-expense competitors.
Of course, low expenses aren't the only thing to consider when buying a bond fund. You should also look for a fund with a short or intermediate weighted average maturity - less thank say, 12 years.
Over the long haul, such bonds have outperformed long-term bonds with a lot less risk. You'll also want to find a fund with an experienced manager who's delivered above-average performance year after year.
And don't fixate on yield. Total return, which includes yield plus capital appreciation, is the better number.
Some bond funds that meet all these criteria are:
- Benham GNMA Income (800-331-8331), with expenses of 0.54 percent.
- Harbor Bond (800-422-1050), with expenses of 0.77 percent.
- Vanguard Fixed Intermediate Corporate (800-635-1511), with expenses of 0.28 percent.