Choosing a financial instrument to invest in should mirror your appetite for risk. If you’re looking to earn a higher yield than what cash ISAs and Treasury Bonds pay, but take less risk than stocks and shares, then it might be worth considering a bond index fund. One of the largest funds currently active in the bond space is that of the Vanguard Total Bond Market Index Fund.
The fund typically invests 30% into low-risk corporate bonds, with the rest injected into risk-free government bonds. The overall benefit of investing in the Vanguard Total Bond Market Index Fund is that your money will be actively managed for you.
You still need to assess whether or not a bond fund is right for your long-term investment goals before parting with your money. In this article, we explain how the Vanguard Total Bond Market Index Fund works, how much you can make, minimum investments, and more.
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What is a Bond Index Fund?
Before we cover the ins and outs of the Vanguard Total Bond Market Index Fund, let’s make sure that you know how a bond index actually works. In a nutshell, by investing in a bond fund, you will have your money managed for you by an established fund provider. Providers such as Vanguard will actively buy and sell bonds in the open marketplace, with the view of making money for their investors.
Bond funds come in a range of shapes, sizes, and risk spectrums. For example, while some focus on low-risk government securities like Treasury bonds and Gilts, others target higher-risk markets. This might include corporations based on the emerging economies or government bonds that are backed by weaker currencies. Either way, you need to choose a bond fund that meets your appetite for risk.
Let’s look at a quick example of a bond index fund that might work in practice.
- You invest $10,000 into a bond index fund
- The fund manager buys and sells US corporate bonds
- At the end of each month, you will receive your share of coupon payments that the index fund receives
- The exact monthly yield that you receive will vary, depending on the economic activity of the fund
- At the end of each year, you will receive your share of any capital gains that the bond fund made
- Capital gains relate to profits made when the fund manager sold bonds on the open marketplace at a profit
As you can see from the above example, there’s much to learn about bond fund indexes, not least because you have the potential to make money on two fronts. Firstly, you will receive coupon payments at the end of each month. The amounts that you receive will be proportionate to the amount you invest at the bond fund. Secondly, you will also receive capital gains at the end of each year, which are based on the profits made when the fund manager sold bonds on the secondary market.
What is the Vanguard Total Bond Market Index Fund?
So now that you have a basic understanding of how a bond fund works in practice, we are now going to explore the specifics of the Vanguard Total Bond Market Index Fund. In a nutshell, the Vanguard Total Bond Market Index Fund is one of the largest bond funds in the financial markets. At the time of writing, the fund has more than $259 billion under management, with an investment basket that contains over 17,000 individual bonds.
The fund is perceived as a low-risk investment product, due to the types of bonds that it targets. While the exact numbers will vary depending on market conditions, the Vanguard Total Bond Market Index Fund typically invests 30% of its portfolio in corporate bonds, with the rest made up of government securities.
30% in Corporate Bonds
The Vanguard Total Bond Market Index Fund will invest around 30% of its portfolio into corporate bonds. These are usually large-scale companies that are listed on either the New York Stock Exchange (NYSE) or NASDAQ. Although the corporate bond space does come with more risk in comparison to government securities, Vanguard will focus on low-risk entities. Think along the lines of Nike, Apple, and Ford Motors.
70% in US Securities
The Vanguard Total Bond Market Index Fund will invest the remainder of its capital into low-risk government securities. For those unaware, these refer to US Treasury Bills. As such, the bonds are backed by the US government, meaning they are virtually risk-free. This allows you to enjoy the higher yields that come with corporate bonds, while at the same time having the safety net of US securities.
How Does the Vanguard Total Bond Market Index Fund Work?
As noted above, Vanguard currently has a surplus of 17,000 corporate and government bonds within its basket. This allows Vanguard to diversify across multiple segments of the bonds space, allowing it to mitigate the risks of default. Irrespective of the type of bond that Vanguard invests in, the fund provider will rarely hold on to its bonds until maturity.
Instead, the fund is actively managed, meaning that it will constantly buy and sell its bonds on the secondary marketplace. As a result, you won’t know how much you are going to make when investing in the Vanguard Total Bond Market Index Fund. Instead, the yield is determined by the performance of the fund manager.
We are now going to explain in more detail how you can make money from the Vanguard Total Bond Market Index Fund.
Monthly Interest Payments at Vanguard
If you’ve previously invested in bonds, then you’ll know that they typically come with coupon payments that are distributed every 6 or 12 months. This allows you to earn passive income without needing to actively manage your investment.
This also allows you to know exactly how much your investment is going to make until the bonds mature. However, the Vanguard Total Bond Market Index Fund operates in a completely different manner, not least because it does not hold on to its bonds until maturity. Instead, it will attempt to profit when the value of the bond goes up.
- You will still receive coupon payments for as long as Vanguard keeps hold of them. When you consider that the Vanguard Total Bond Market Index Fund has more than 17,000 bonds in its basket, this means that the provider is likely to receive coupon payments throughout the month.
- When it does, you will receive your share of the coupon payment, proportionate to the amount you have invested at Vanguard.
- The amount that you receive each month will never be the same. This is because Vanguard will sell bonds, and then purchase new ones. Each bond will, of course, come with a different coupon rate, which is why your monthly interest payments will vary.
Here’s an example of how you might make monthly interest payments via the Vanguard Total Bond Market Index Fund.
- You have $30,000 invested in the Vanguard Total Bond Market Index Fund
- During month 1, Vanguard receives 0.5% in coupon payments from its total bond investments
- As you have invested $30,000, this means that you will receive $150 in interest (0.5% x $30,000)
- In month 2, Vanguard receives 1% in coupon payments, so you make an additional $300 (1% x $30,000)
Annual Capital Gains at Vanguard
Here’s where things get interesting. While a traditional bond investment only allows you to earn annual or bi-annual coupon payments until the bonds mature, a bond fund also gives you the chance to make capital gains. This is because Vanguard will actively look to sell its bond holdings on the secondary market at a higher price than it paid. Although corporate and government bonds always come with a fixed rate of interest, the underlying value of the bonds will go up or down based on market conditions.
- Let’s say that Vanguard holds bonds in Nike PLC, which pays an annual coupon rate of 5%.
- When the bonds were issued, Nike PLC had a Standard & Poor’s risk rating of BB.
- However, as Nike PLC published strong earnings in its most recent report, it has since been upgraded to a rating of A.
- This means that the risks of the bonds are now much lower, so the value of the bonds will go up.
- When bonds increase in value on the secondary market, bondholders can sell them at a premium.
- As such, funds like Vanguard will make a profit for their investors, which is paid as capital gains.
It would be a logistical nightmare to distribute capital gains to investors as and when Vanguard sells its bonds, which is why they are paid at the end of each year. The amount that you receive will be determined by the amount you have invested at Vanguard. For example, if the fund provider reports an annual gain of 7%, and you have $5,000 invested, you will receive $350 in capital gains. This is on top of the monthly coupon payments that you received throughout the year.
Fees and Minimum Investment
As is the case with all bond index funds, you will need to pay a fee at Vanguard. This is to cover the costs of having your money actively managed for you. Don’t forget, the fund comes with a team of highly experienced investors that will be analyzing the markets each and every day. This not only includes adding new bonds to its basket but also the process of looking for selling opportunities.
The Vanguard Total Bond Market Index Fund charges an annual expense ratio of 0.15%, which is very competitive. The fee is calculated against the amount you have invested with the provider. For example, a $50,000 investment would cost you just $75 per year.
- If you’re wondering why the fees are so low, this is because providers like Vanguard need capital to fund their operations. If they didn’t have investors ploughing cash into the business, they wouldn’t be able to meet their investment goals.
- You also need to consider that Vanguard needs sufficient levels of cash flow at its disposal to meet withdrawals.
- In terms of minimum investments, the Vanguard Total Bond Market Index Fund permits deposits of $3,000 or more.
- If you don’t want to inject $3,000 in one-hit, then you might be able to use a third-party to access the fund. They usually allow you to invest less, as the account minimum is covered by other investors at the platform.
Investment Returns on the Vanguard Total Bond Market Index Fund
Although historical returns should not be used to determine the future direction of bond funds, at the very least it allows us to gauge how much you might be able to make. The following figures are based on annualized returns.
As you can see from the above figures, the Vanguard Total Bond Market Index Fund has provided its investors with steady returns over the past decade. The yields mirror that of the types of securities that Vanguard buys and sells, so investors have enjoyed decent gains on an investment that carries little risk.
For example, let’s say that you invested $15,000 into the Vanguard Total Bond Market Index Fund 10 years ago, and you haven’t made any withdrawals. Based on a 10-year annualized yield of 3.73%, your $15,000 investment would now be worth $21,633.91. This represents an ROI (return on investment) of 44.22%, which is attractive.
Withdrawing Your Investment at Vanguard
You also need to make some considerations regarding withdrawals when investing in an index fund. This is because some providers will install an initial redemption period. This means that you cannot withdraw your investment until the redemption period concludes.
For example, if the fund has a minimum redemption of 12 months, this means that your cash will be locked up for 1 year. After that, you can make a withdrawal. However, you then need to explore whether or not the fund provider changes a withdrawal fee, which is often the case.
- The Vanguard Total Bond Market Index Fund does not have a redemption date, so you can make a withdrawal whenever you see fit
- However, Vanguard will charge you $50 if you make a withdrawal within 60 days of making your investment
- The amount you get back will be based on the fund’s NAV (Net Asset Value).
- Once you redeem your investment, Vanguard will transfer the funds into your bank account within 3-5 days.
- Ultimately, the Vanguard Total Bond Market Index Fund is a reasonably liquid asset class, as you’ll be able to turn your investment into cash in less than one week.
Vanguard Total Bond Market Index Fund: Pros and Cons
- Vanguard is one of the most established fund providers in the investment space
- The fund invests in low-risk securities
- 30% of the fund is injected into corporate bonds, with the rest invested in government securities
- The fund has provided an annualized yield of 3.73% over the past 10 years
- You can withdraw your investment at any time
- Low expense ratio of 0.15%
- Minimum investment of $3,000 if going direct with Vanguard
- Yields are much lower than the stocks and shares arena
- You will need to use a broker if Vanguard doesn’t support your country
- Unable to assess how much you will make as yields vary on a month-by-month basis
How do I Invest in the Vanguard Total Bond Market Index Fund?
Like the sound of the Vanguard Total Bond Market Index Fund and looking to make an investment today? If so, you’ve got two options at your disposal. If you’re based in a location that Vanguard supports, you would be best off investing directly with the fund provider. This is because Vanguard does not charge any investment fees other than the 0.15% expense ratio that we discussed earlier.
If you’re not based in a supported country or you don’t want to meet the $3,000 minimum investment, you will need to use a third-party broker. Due to the sheer size of the Vanguard Total Bond Market Index Fund, most major brokers will allow you to access it.
Here’s what you need to do to make an investment today.
Step 1: Open an Account With Vanguard or a Broker
If you’re based in a country that Vanguard supports (such as the US), then you will need to visit the Vanguard website to open an account. Alternatively, you will need to find a broker that supports your country of residence. Either way, you will need to provide some personal information to get the account registration process underway.
This should include your:
- First and Last Name
- Home Address
- Country of Residence
- Tax Status
- Date of Birth
- Social Security Number (if applicable)
- Contact Details
Step 2: Verify Your Identity
Regardless of whether you are using Vanguard or a third-party broker, you will need to verify your identity before you can make an investment. The specific process will vary from broker-to-broker, although this usually requires you to upload a government-issued ID (passport or driver’s license) and a proof of address (bank statement or utility bill).
Step 3: Fund Your Account
You will now need to fund your brokerage account. If using Vanguard, you will need to deposit funds via a bank transfer. This can take a few days to arrive. If using a broker, you might be able to deposit funds with a debit/credit card, and even an e-wallet like PayPal.
Step 4: Invest in the Vanguard Total Bond Market Index Fund
As soon as your deposit is credited, you can invest in the Vanguard Total Bond Market Index Fund. You will need to enter the amount that you wish to inject into the fund, before confirming the investment. Don’t forget, if you’re going direct with Vanguard, you will need to meet a minimum investment of $3,000.
If you’ve read our guide from start to finish, you should now know whether or not the Vanguard Total Bond Market Index Fund meets your long-term investing goals. Ultimately, the fund is best suited for those of you that are looking to earn a higher yield than traditional bank accounts pay, but still, keep your risk levels low.
Although the Vanguard Total Bond Market Index Fund is not risk-free, it does invest 70% of its capital into US government securities. With the remaining 30% invested in corporate bonds, this allows you to enjoy a higher rate of return for your money. All of this can be achieved at an annual expense ratio of just 0.15%.
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How much will I make from the Vanguard Total Bond Market Index Fund?
There is no knowing how much you will make from the Vanguard Total Bond Market Index Fund, as this will depend on the performance of the fund itself. With that said, the fund has made an average annualized return of 3.73% over the past 10-years.
What is the minimum amount that I can invest in the Vanguard Total Bond Market Index Fund?
If you go direct with Vanguard, you will need to invest at least $3,000 into the fund. However, if you invest via a third-party broker, you'll likely be able to invest less.
What expense ration does the Vanguard Total Bond Market Index Fund charge?
Vanguard charges a very competitive expense ratio of 0.15%. If investing with the fund provider directly, you will also avoid commissions.
When can I cash in my Vanguard Total Bond Market Index Fund investment?
The Vanguard Total Bond Market Index Fund does not come with a minimum redemption period. This means that you can withdraw your holdings whenever you see fit. Take note, if you withdraw your money within 60 days of making the investment, you'll pay a fee of $50.
Is the Vanguard Total Bond Market Index Fund risky?
All investments come with an element of risk. With that said, the Vanguard Total Bond Market Index Fund is perceived as a low-risk investment. This is because it invests in low-risk corporate bonds and government securities.
How much does the Vanguard Total Bond Market Index Fund have under management?
At the time of writing, the Vanguard Total Bond Market Index Fund has just over $259 billion under management.
When do I receive my coupon payments from the Vanguard Total Bond Market Index Fund?
As Vanguard will likely receive coupon payments sporadically, it distributes your share at the end of each month.