VWOB or BND: Which Bond ETF Should You Buy?

Times of uncertainty in the global economy, and concerns about high stock valuations, might make some investors consider diversifying into bonds. One of the easiest ways for most everyday household investors to buy bonds is to invest in bond exchange-traded funds (ETFs).

One of the simplest and lowest-cost bond ETFs is the Vanguard Total Bond Market ETF (NASDAQ: BND). But some investors might be interested in earning higher yields in exchange for some higher risks. One way to try for higher yields on bonds is to buy the Vanguard Emerging Markets Government Bond ETF (NASDAQ: VWOB). Instead of U.S. dollar-denominated bonds like those held by BND, VWOB lets you invest in government-issued debt from emerging markets around the world.

Emerging market government debt tends to be higher-risk than U.S. government debt, and it might not be right for many investors. But VWOB has outperformed the Vanguard Total Bond Market ETF in the past year -- and for the past several years.

Let's take a closer look at these two Vanguard bond ETFs and see which fund could be a better buy.

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VWOB: 902 government bonds from emerging markets

The Vanguard Emerging Markets Government Bond ETF owns a total of 902 bonds that were issued by foreign governments in countries that are categorized as "emerging market" economies. Just like buying a U.S. Treasury bond, buying VWOB means that you are investing in government debt. But instead of the U.S. government, VWOB owns government-issued debt of countries like Saudi Arabia, Mexico, Turkey, and Indonesia, which are among the fund's top holdings.

VWOB charges an expense ratio of 0.15%, which is higher than BND. But VWOB has delivered strong performance for the past several years, with average annual returns (by net asset value) of 4.2% for the past 10 years, 2.6% for the past five years, 9.99% for the past three years, and 11.6% for the past year.

10% returns on a bond ETF might sound like a great deal, but keep in mind that there are special risks of investing in emerging market government debt. Vanguard rates VWOB as a 3 out of 5 on the company's risk/reward scale, so it should be considered a higher-risk investment than BND (which is only rated a 2 out of 5).

Some emerging market governments struggle to repay their debts. Emerging markets are often smaller, lower-income countries that are more likely to get hit hard by economic turmoil, political instability, natural disasters, or energy price shocks like what we're seeing now from the war in Iran. Those vulnerabilities can make emerging market governments a bigger risk to default on their debt. If a country defaults on its national debt, that country's bond investors (like you) lose money.

Approximately 41% of VWOB's bond holdings are rated BB or lower. That means those bonds are non-investment grade with "substantial, high or very high" credit risk. Bond investors get paid higher yields in exchange for lending to these higher-risk borrowers. But there's no guarantee that all these lower-rated countries will continue to make payments on their debts.

BND: Simple low-cost bond ETF

The Vanguard Total Bond Market ETF is a broadly diversified bond ETF that gives you exposure to 11,429 bonds across the taxable, investment-grade, U.S. dollar-denominated bond market. BND has delivered average annual returns (by net asset value) of 1.95% for the past 10 years, 0.4% for the past five years, 5.1% for the past three years, and 6.1% for the past year.

BND mostly owns U.S. government bonds, which make up 69% of the fund. The other 31% of bonds are "investment grade" with credit ratings of BBB or higher. This bond ETF is not 100% safe from default risk, as it includes some corporate bonds, mostly in the industrial and finance sectors. Bond ETFs like BND also have a risk of prices declining when interest rates go up, such as what happened in 2022 during the Fed's recent rate-hiking cycle.

But in general, the Vanguard Total Bond Market ETF is considered a relatively "safe" investment that can be appropriate to help diversify your portfolio away from the market risk of stocks. It charges a low expense ratio of 0.03%.

VWOB or BND: Head-to-head comparison

If you want to choose which bond ETF to buy, here's a quick side-by-side breakdown of how these two funds compare.

Data source: Vanguard.

Choosing the best bond ETF depends on your investment style. I prefer to avoid taking big risks with my bond holdings, and I own the Vanguard Total Bond Market ETF. So if you're like me and you want a simple, straightforward, low-cost way to use bonds to diversify your portfolio, BND is a solid choice. But if you can tolerate the potentially higher risks of emerging market debt, VWOB might offer bigger returns.

Ben Gran has positions in Vanguard Total Bond Market ETF. The Motley Fool has positions in and recommends Vanguard Total Bond Market ETF. The Motley Fool has a disclosure policy.