5 Long Term Bond ETFs You Should Know

Long-term bond ETFs are gaining attention as investors bet that the Fed may be nearing the end of its rate hiking cycle. This is because of the inverse relationship between interest rates and bond prices, which means that long-term bond prices are expected to rise more than bonds with shorter maturities when rates begin to fall again. However, there’s more downside risk when interest rates are rising. 

See a list of the largest long-term bond ETFs and find out how these fixed income funds work, including the pros and cons of investing in them. 

What Are Long Term Bond ETFs? 

Long-term bond ETFs are exchange-traded funds that track the performance of a basket of long-term bonds. ETFs are investment funds traded on stock exchanges, and they are designed to replicate the performance of an underlying index or asset.  

Long-term bonds typically have maturities of 10 years or more, and they are issued by governments, municipalities and corporations to raise capital. These bonds usually offer higher interest rates than short-term bonds, compensating investors for the longer holding period and greater exposure to interest rate risk. 

Long Term Bond ETFs and Interest Rate Risk 

Other than yield, some investors buy long-term bond ETFs when they expect interest rates to fall. This is because of the inverse relationship between rates and bond prices. The longer the maturity of a bond, the greater the interest rate sensitivity. So, if interest rates fall, long-term bonds generally rise more in price than short-term and intermediate-term bonds.  

List of Long-Term Bond ETFs: Top 5 by AUM 

Here is a list of the top five long-term bond ETFs by AUM as of July 31, 2023: 

Long Term Bond ETF Pros and Cons 

Investing in long-term bond ETFs has both advantages and disadvantages. Let's take a look at some of the pros and cons: 

Pros of Investing in Long Term Bond ETFs 

• Steady income generation: Long-term bond ETFs offer a reliable source of income through regular interest payments (coupon payments) from the underlying bonds. This can be particularly attractive for income-oriented investors, retirees or those seeking stable cash flow. 
• Diversification: By investing in a long-term bond ETF, especially one that tracks a broad market index, investors gain exposure to a diversified portfolio of long-term bonds issued by various entities (governments, corporations, municipalities). This diversification can help reduce the impact of default risk associated with individual bonds. 
• Liquidity: Long-term bond ETFs trade on stock exchanges throughout the day, providing investors with easy access to buying and selling shares. This liquidity makes it convenient for investors to enter or exit positions without the challenges of trading individual bonds. 
• Lower investment threshold: Investing in an ETF allows you to access a broad range of long-term bonds with a relatively low investment threshold. This is especially beneficial for retail investors who may not have the financial resources to build a diversified bond portfolio on their own. 
• Cost efficiency: Long-term bond ETFs typically have lower expense ratios compared to actively managed bond mutual funds. These lower costs can positively impact the overall returns for investors over the long term. 

Cons of Investing in Long Term Bond ETFs 

• Interest rate risk: Long-term bond ETFs are highly sensitive to changes in interest rates. If interest rates rise, the prices of long-term bonds in the ETF's portfolio may decline, leading to potential capital losses for investors. 
• Lower yield in low-rate environments: In a low-interest-rate environment, the yield offered by long-term bond ETFs may be relatively low, and investors may not see significant income generation compared to historical periods with higher interest rates. 
• Potential volatility: Long-term bond ETF prices can be subject to volatility, especially during periods of economic uncertainty or market turbulence. This volatility can be challenging for investors who seek stable returns or capital preservation. 
• Inflation risk: Inflation can erode the purchasing power of bond returns over time. Long-term bonds, in particular, are more susceptible to inflation risk as they have longer durations, and their fixed interest payments may not keep pace with rising consumer prices. 
• Credit risk: While bond ETFs provide diversification, they are still subject to credit risk. If the underlying bonds in the portfolio are issued by entities with poor credit quality, there is a risk of default, which can negatively impact the ETF's performance. 
• Interest rate timing: Investing in long-term bond ETFs requires making predictions about future interest rate movements. Timing interest rate changes accurately can be challenging, and getting it wrong may lead to suboptimal returns. 

How Are Long Term Bond ETFs Taxed? 

Long-term bond ETFs are generally taxed similarly to other bond ETFs. The taxation can vary depending on the specific characteristics, such as interest income, dividend payments and the issuer of the underlying bond holdings.  

Here's how long-term bond ETFs are typically taxed in the U.S.: 

• Interest income (coupon payments): Long-term bond ETFs generate income through interest payments (coupon payments) from the underlying long-term bonds held in the portfolio. This interest income is generally taxable as ordinary income in the year it is received. The income is reported on the investor's tax return and is subject to the individual's income tax rate. 
• Qualified dividend income: If the long-term bond ETF holds bonds issued by U.S. corporations or qualified foreign corporations, it may generate qualified dividend income. Qualified dividends are generally taxed at lower preferential tax rates than ordinary income. To be eligible for this lower tax rate, the investor must meet certain holding period requirements for the ETF shares. 
• Capital gains and losses: When an investor sells their long-term bond ETF shares at a profit (capital gain), they will be subject to capital gains tax. The capital gains tax rate can vary depending on the investor's holding period. If the shares are held for more than one year, the gain is typically considered a long-term capital gain, which enjoys lower tax rates than short-term capital gains (shares held for one year or less). 
• Reinvested dividends: Many bond ETFs automatically reinvest dividends back into the fund, buying additional shares on behalf of the investor. Even though the investor doesn't receive these dividends in cash, they are still considered taxable income for the year in which they are reinvested. 
• Tax-exempt bond ETFs: Some long-term bond ETFs invest in municipal bonds issued by state and local governments. The interest income from these bonds is often exempt from federal income tax and may also be exempt from state income tax if the investor resides in the same state as the issuing municipality. 
• Tax efficiency: Long-term bond ETFs, like other ETFs, are generally more tax efficient compared to mutual funds due to their unique structure. The creation and redemption process used by ETFs helps minimize capital gains distributions, reducing the tax burden for investors in taxable accounts. 

Bottom Line on Investing in Long Term Bond ETFs 

As with any investment, there are risks involved when investing in long-term bond ETFs. It's crucial for investors to understand their risk tolerance, investment goals and time horizon before considering any investment in the bond market. Additionally, diversification across various asset classes and regular review of the investment strategy with the help of a financial advisor is recommended.