This Bond ETF Has a Special Tax Advantage Over One of Fidelity's Top Bond Fund

This comparison looks at two core bond ETFs on the market: the Fidelity Total Bond ETF (NYSEMKT:FBND), and the iShares National Muni Bond ETF (NYSEMKT:MUB). Both may appeal to income-seeking investors, but each has different risks and tax profiles. MUB is a long-established municipal bond fund, while FBND is a diversified taxable bond ETF with a tilt toward energy and corporate issuers. Here is a side-by-side breakdown of these funds.

Snapshot (cost & size)

Beta measures price volatility relative to the S&P 500; beta is calculated from five-year weekly returns. The 1-yr return represents total return over the trailing 12 months.

FBND has a notably higher expense ratio, but it also offers a higher dividend yield and 1-year return. However, even though FBND has a higher dividend yield, MUB currently pays more in dividends because its share price is twice that of FBND.

Performance & risk comparison

What's inside

Launched in 2014, FBND casts a wide net of bond holdings with 4459 assets, and 67% of its bond holdings are rated AAA, the highest rating for a bond, indicating a very low risk of default from the issuer. However, the ETF also invests up to 20% of its assets in lower-quality debt securities, such as BBB-rated debt, which are riskier but can offer a higher yield.

By contrast, MUB tracks a broad mix of investment-grade U.S. municipal bonds, spreading across 6,163 holdings. It holds zero U.S. government-issued bonds, but about 61% of its holdings are AA-rated bonds, the second-highest rating, with the rest of the fund’s weight almost evenly split between AAA and A-rated bonds.

What this means for investors

Bond ETFs can move differently from typical stock ETFs, as the bond market is recovering from the 2022 crash, and the recovery has been very slow and gradual. Don’t expect quick gains unless an unforeseeable event occurs, such as a dramatic drop in federal interest rates, which would likely cause prices to rise inversely as bonds with higher rates are already locked in at their current rates.

When it comes to FBND and MUB, FBND may offer a higher yield over time because it holds bonds within the B rating bracket, which are riskier but often yield higher payouts by the time they mature.

Because municipal bonds often have lower interest rates than U.S. government bonds, MUB is more likely to have lower yields. However, the main benefit of MUB is its exemption from federal income taxes and state income taxes, depending on the state. So, for a higher-risk/higher-reward option, FBND is ideal, while MUB is the go-to option for more tax benefits.

Glossary

ETF: Exchange-traded fund that trades on an exchange and holds a basket of underlying securities.
Expense ratio: Annual fund operating costs expressed as a percentage of the fund’s average assets.
Dividend yield: Annual dividends paid by a fund divided by its current share price, expressed as a percentage.
1-yr return: Total return a fund generated over the past 12 months, including price change and income.
Max drawdown: The largest peak-to-trough decline in a fund’s value over a specified period.
Growth of $1,000: Illustration showing what a $1,000 investment would be worth after a given time period.
Beta: Measure of a fund’s volatility relative to a benchmark, often the S&P 500 index.
AUM (Assets under management): Total market value of all assets managed by a fund.
Municipal bond: Bond issued by state or local governments, often providing tax-exempt interest income.
Investment-grade: Bonds rated relatively high quality, indicating lower default risk compared with high-yield bonds.
Corporate credit risk: Risk that a corporate bond issuer cannot meet interest or principal payments.
Tax-exempt income: Interest or dividends that are not subject to federal income tax, and sometimes state or local taxes.

For more guidance on ETF investing, check out the full guide at this link.

Adé Hennis has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.