Bogle on Bond Mutual Funds

When I first read "Common Sense on Mutual Funds" 8 years ago it was chapter 7, on bonds, that stood out. It stood out partly because I had already been exposed to the evidence supporting the idea that stock funds net of costs rarely beat their relative indexes. But mostly because of the overwhelming correlation between bond mutual fund expenses and performance.

Bogle examines 4 bond sectors: 1. long term municipal bonds, 2. short term US government bonds, 3. intermediate term US government bonds, and 4. intermediate term corporate investment -grade bonds.

In 3 of 4 of the categories, over a 5 year period, the low cost funds outperformed the higher cost alternatives. In the fourth case, the more expensive bond funds slightly out performed, but with significantly more risk.

Bogle does a nice job of demonstrating this lesson with graphs that chart costs versus return. Visually one can see all the data points and see that the simple low cost bond index fund generally outperforms its actively managed, more expense peers.

He concludes:

"In general, the lowest-cost group had the lowest duration, the lowest volatility, and the highest quality. The lowest-cost group had not only the highest returns, but also the lowest risks. Bond fund investors simply cannot ignore that message.

Finally, the bond cost analysis is a math issue, similar to stock funds. It is more pronounced with bond funds because they return less than stocks, so when fees are netted out it is hard for the active fund to outperform, net of those fees.