Treasury Bond Funds vs. Individual Bonds: Do Funds Burn Investors?

5 Key Points: Treasury Bond Funds vs Individual Bonds

1. Certainty vs. Volatility: Individual Treasury bonds offer guaranteed principal return if held to maturity; Treasury bond funds provide liquidity but their NAV fluctuates daily with interest rates.
2. Long-Term Returns: While fees impact funds, our 20-year analysis showed a Treasury bond fund outperformed a specific individual bond strategy due to factors like reinvestment efficiency (VFITX: 2.93% CAGR vs. Individual: 2.11% CAGR).
3. The "Burned" Feeling: Treasury bond fund NAV declines can create "paper losses" on statements (even if total return with dividends is positive), explaining why some investors feel burned.
4. Effort vs. Convenience: Individual Treasury bonds require active management (reinvestment, tracking); Treasury bond funds automate this but incur expense ratios (though often low).
5. Decision Factors: The best choice in the "Treasury bond funds vs individual bonds" debate depends on your need for certainty, liquidity, tolerance for volatility, and time commitment.

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"I just don't trust bond funds, I got burned!" It's a sentiment I hear often from clients. When seeking stability, many investors turn to bonds, but their experience with bond funds sometimes leaves them feeling confused or shortchanged compared to the perceived simplicity and safety of owning individual bonds. This raises a crucial question: when investing in something as seemingly straightforward as U.S. Treasury bonds, is buying them individually truly better or safer in the long run than using a fund?

To get a clear comparison of these two approaches – direct ownership versus a fund structure (like a mutual fund or ETF) – we need to isolate the mechanics of the vehicles themselves from the risk of the underlying investment defaulting. That's why this article focuses specifically on U.S. Treasury bonds. Backed by the full faith and credit of the U.S. government, they are considered among the safest investments globally, unlike corporate bonds where the issuer's financial health adds another layer of risk. By concentrating on Treasuries, we can better understand the inherent differences between buying bonds one by one versus holding them within a fund.

So, if the underlying bonds are ultra-safe, why do experiences differ, and why the persistent feeling among some investors of being "burned" by funds? Does the common hypothesis – that long-term returns should be similar minus fund fees – hold water, or are other factors at play? Let's dive into how each method works, compare their performance characteristics both short and long-term (including a detailed 20-year analysis), and see if the numbers and mechanics align with investor sentiment or reveal a more nuanced picture.

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Individual Treasury Bond Mechanics

When you buy an individual Treasury bond (or Note or Bill), you are lending money directly to the U.S. government for a set period (maturity).

• Predictable Income: You receive fixed interest payments (coupons) at regular intervals (typically semi-annually).
• Return of Principal: At the maturity date, you receive the bond's face value (principal) back.
• Certainty (If Held to Maturity): If you hold the bond until it matures, you know exactly what your return will be, barring the extremely unlikely event of a U.S. government default. Your return is locked in, regardless of interest rate fluctuations during the holding period.
• Interest Rate Risk (If Sold Early): If you need to sell the bond before it matures, its price on the secondary market will have changed if interest rates have moved. If rates have risen since you bought the bond, its price will likely fall (as new bonds offer better yields). If rates have fallen, its price will likely rise.
• Costs: You avoid ongoing management fees. However, buying individual bonds, especially in smaller quantities, might involve less favorable pricing (wider bid-ask spreads) compared to large institutional buyers like funds.

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Treasury Bond Fund Mechanics

Treasury bond funds pool money from many investors to buy a diversified portfolio of Treasury securities.

• Diversification: Funds hold numerous bonds with varying maturity dates, spreading risk.
• Liquidity: Fund shares (especially ETFs) can typically be bought and sold easily on any business day at the current market price (Net Asset Value or NAV).
• Variable Income: Funds distribute income (usually monthly) generated by the underlying bonds. This distribution amount can fluctuate as the fund buys and sells bonds and as interest rates change.
• No Maturity Date: Unlike individual bonds, most bond funds don't have a set maturity date. They aim to maintain a target average maturity or duration by continuously buying and selling bonds.
• NAV Fluctuation: A Treasury bond fund's Net Asset Value (NAV) fluctuates daily based on the market value of its bond holdings. When interest rates increase, the value of existing bonds in the portfolio typically decreases, leading to a lower NAV (and vice versa). Consequently, your principal value is not guaranteed, even in a fund comprised solely of U.S. Treasury bonds. Furthermore, market sentiment can significantly impact fund prices. Similar to stocks, news and external factors can cause a divergence between a fund's trading price and the intrinsic value of its underlying assets. This discrepancy can significantly affect your returns, particularly if you need to sell your holdings when the market is volatile. However, during periods of extreme market panic, such as the March 2020 COVID-19 market crash, this characteristic can be advantageous, as Treasury fund values increased while most other asset classes declined.
• Costs: Treasury bond funds charge an annual expense ratio to cover management, administrative, and other operational costs. This fee is directly deducted from the fund's assets, which reduces the net return for investors. While efficient funds can have very low expense ratios, such as 0.03% for the Schwab Intermediate-Term U.S. Treasury ETF (SCHR), this cost should always be taken into account.

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Short-Term Comparison: Certainty vs. Volatility

In the short term, the experiences can be quite different:

• Individual Bond (Held to Maturity): Immune to interest rate fluctuations in terms of final payout. If you buy a 2-year Treasury note yielding 4%, you will get your principal back plus 4% annual interest (paid semi-annually) after 2 years, regardless of what rates do in the meantime.
• Treasury Bond Fund: Highly sensitive to interest rate changes. If rates rise shortly after you invest, the fund's NAV will likely drop, potentially showing a short-term loss on paper, even though the fund is collecting interest from its bonds and anticipating the return of principal as those underlying bonds mature. Conversely, falling rates or a general market panic about other more risky assets can boost the NAV, providing short-term capital appreciation alongside income distributions.

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Long-Term Comparison: Do Returns Converge (Minus Fees)?

This is where the hypothesis comes in and the real impact for the long term portfolios we build for clients. If an investor holds an individual bond to maturity and then reinvests the principal into a new bond at the prevailing rate, and continues doing this over decades, does their experience mirror that of a bond fund investor?

• Reinvestment Dynamics: Both approaches involve reinvesting over time. A bond fund does this continuously as bonds mature or are traded. An individual bond investor does this only when their specific bond matures (or if they sell early and reinvest). Over long periods, both methods mean the portfolio's yield will generally track prevailing interest rates.

• The "Hold to Maturity" Advantage Diminishes: The certainty advantage of an individual bond applies only until its maturity date. If the goal is long-term investment requiring reinvestment, the investor faces the same reinvestment risk (uncertainty about future rates) as the fund, just at different intervals. Vanguard research suggests holding individual bonds to maturity offers little financial benefit over pooled products when cash flows are reinvested.
• The Impact of Expense Ratios: The expense ratio is the most quantifiable difference between individual bonds and bond funds. A bond fund's returns are invariably reduced by its expense ratio. However, this must be balanced against the time, effort, and potential risk of missing reinvestment opportunities when manually rolling over individual bonds. For example, with a very low fund expense ratio of 0.03% and an assumed current interest rate of 4.0%, being uninvested for just 2.73 days would negate the entire annual savings achieved by avoiding that minimal expense ratio.

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A 20-Year Historical Example (Approx. 2005-2025):

To illustrate these concepts with real numbers, let's examine the historical performance over the 20-year period ending approximately March 31, 2025. We’ll use the Vanguard Intermediate-Term Treasury Fund (VFITX) to compare to the individual bonds. Although this has a higher expense ratio (0.20%) than my previously cited more efficient fund, I don’t want to cherry-pick the low-cost fund.

The Vanguard Intermediate-Term Treasury Fund has an average bond duration of 5.28 years. This means that, on average, the fund's bond holdings have a sensitivity to interest rate changes that is equivalent to a bond with a 5.28-year maturity. Therefore, we will use the return of individual 5-year bonds for our comparison.

• Methodology Challenge: When using individual bonds like we’re about to do, your duration will never actually be 5 years because the bonds are always aging, diminishing towards zero on the day you roll over the bonds. This means that the interest rate sensitivity (and arguably, risk profile) is always changing using individual bonds, undulating between being an intermediate-term bond and a short-term bond depending where you are in the bond cycle. This could be viewed as an additional weakness of individual bonds and definitely creates an apple-to-oranges comparison, but hey, that’s what you’re getting by implementing the individual bond strategy. There is also the issue of reinvestment; T-notes pay a fixed rate of interest semi-annually (every six months) based on their coupon rate and par value. You receive these interest payments as cash. While you can then reinvest those payments to achieve compounding on your end, the T-note itself simply makes these periodic fixed payments until maturity. For our analysis, we will assume that all coupon payments will be reinvested at the same rate as the bond during that period.
• Fund Proxy: Vanguard Intermediate-Term Treasury Fund Investor Shares (VFITX). It invests in 5-10 year Treasuries, has existed for over 20 years, and currently charges an expense ratio of 0.20%.
• Individual Bond Yields & Assumptions: Since we are using individual 5-year bonds rolled over every 5 years, we really only need to look up the 5-year Treasury note rate on four key dates: April 1, 2005; April 1, 2010; April 1, 2015; and April 1, 2020, assuming each bond is held to maturity before rolling over. Here are the yields at those dates:
  
  • April 1, 2005: 4.00% - This was during a period of rising interest rates following the early 2000s recession.
  • April 1, 2010: 2.58% - Reflecting the low-rate environment in the aftermath of the 2008 financial crisis.
  • April 1, 2015: 1.50% - Rates remained low as the economy continued its recovery, with the Federal Reserve maintaining accommodative monetary policy.
  • April 1, 2020: 0.39% - This rate reflects the significant decline in yields during that period, influenced by the Federal Reserve's monetary policy actions in response to the economic impact of the COVID-19 pandemic.
• Individual Bond Performance: For each 5-year period, we will calculate:

• The semi-annual coupon payment based on the principal invested at the start of that period.
• The future value of these 10 semi-annual payments, assuming they are reinvested at the period's semi-annual interest rate. We use the Future Value of an Ordinary Annuity (FVA) formula:  FVA = P * [((1 + r)^n - 1) / r] where P is the semi-annual payment, r is the semi-annual interest rate, and n is the number of payments (10).
• The total value at the end of the period is the principal invested at the start plus the FVA of the coupons.
• Period 1: April 1, 2005 - March 31, 2010
  
  • Starting Principal: $100,000.00
  • Coupon Rate: 4.00% per year | Semi-Annual Rate (r): 2.00% (0.02)
  • Semi-Annual Coupon (P): $2,000.00
  • Future Value of Coupons (FVA₁): $21,899.40
  • Total Value at March 31, 2010: $100,000.00 + $21,899.40 = $121,899.40
• Period 2: April 1, 2010 - March 31, 2015
  
  • Starting Principal: $121,899.40
  • Coupon Rate: 2.58% per year | Semi-Annual Rate (r): 1.29% (0.0129)
  • Semi-Annual Coupon (P): $1,572.40
  • Future Value of Coupons (FVA₂): $16,659.78
  • Total Value at March 31, 2015: $121,899.40 + $16,659.78 = $138,559.18
• Period 3: April 1, 2015 - March 31, 2020
  
  • Starting Principal: $138,559.18
  • Coupon Rate: 1.50% per year | Semi-Annual Rate (r): 0.75% (0.0075)
  • Semi-Annual Coupon (P): $1,039.19
  • Future Value of Coupons (FVA₃): $10,749.62
  • Total Value at March 31, 2020: $138,559.18 + $10,749.62 = $149,308.80
• Period 4: April 1, 2020 - March 31, 2025
  
  • Starting Principal: $149,308.80
  • Coupon Rate: 0.39% per year | Semi-Annual Rate (r): 0.195% (0.00195)
  • Semi-Annual Coupon (P): $291.15
  • Future Value of Coupons (FVA₄): $2,937.81
  • Total Value at March 31, 2025: $149,308.80 + $2,937.81 = $152,246.61
• Conclusion: Based on the rates provided and the assumption of reinvesting all semi-annual coupons at the bond's original rate until maturity before rolling over, your initial $100,000 investment on April 1, 2005, would grow to approximately $152,246.61 by March 31, 2025, representing a 2.11% Compound Annual Growth Rate (CAGR) for this 20-year period.
• Calculating VFITX Bond Fund Performance: Well, if that made your eyes gloss over, calculating the 20-year return figure of a bond fund is even harder. The difficulty arises from a constantly changing share price as well as constantly changing dividend distributions which, we are assuming, are reinvested at the aforementioned constantly changing share price. There is no simple formula that will calculate the return like the one above for the individual bonds; it’s a matter of tracking down 20 years of data. Fortunately, Yahoo Finance was able to come through for us and had the daily transaction data for the entire 20-year period. With that, we were able to create an excel sheet tracking the share values, dividend amounts, capital distribution dates, and amounts to calculate the additional share purchases from reinvestment to calculate the return. To account for fees, annually around April 1 (including at the end of the time period) the 0.20% annual expense ratio was deducted based on the average account value during the year. Here is the sheet in all its glory.
• Conclusion: Based on the magnificent spreadsheet generated, your initial $100,000 investment on April 1, 2005, would grow to approximately $178,278 by March 31, 2025, representing a 2.93% Compound Annual Growth Rate (CAGR) for this 20-year period.

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Fund vs. Individual Bond Performance: The 20-Year Results

Our detailed 20-year analysis (April 1, 2005 - March 31, 2025) provides concrete numbers to compare the two approaches, using the Vanguard Intermediate-Term Treasury Fund (VFITX) as our fund proxy and a strategy of rolling over 5-year individual Treasury notes as our individual bond proxy:

• Individual Bond Strategy (Rolling 5-Year Treasuries): Starting with $100,000 and reinvesting semi-annual coupons at the original rate for each 5-year bond before rolling over yielded approximately $152,246.61 (2.11% CAGR).
• VFITX Fund Strategy (Dividends Reinvested, Fees Deducted): Starting with $100,000, reinvesting all distributions and accounting for the 0.20% annual expense ratio yielded approximately $178,278 (2.93% CAGR).

In this specific historical example, the Treasury bond fund (VFITX) significantly outperformed the strategy of rolling individual 5-year Treasury notes, even after accounting for its 0.20% expense ratio.

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Revisiting the Hypothesis

Our initial hypothesis suggested that long-term returns between individual bonds (with reinvestment) and bond funds might converge, with the primary difference being the fund's expense ratio. However, our 20-year analysis shows a different outcome for this specific period and methodology. The fund outperformed the individual bond strategy by a notable margin (2.93% CAGR vs. 2.11% CAGR).

Why the difference, especially when the fund had fees and the individual bond strategy didn't (in our model)? Several factors contribute:

1. Methodology Limitations: As noted, the individual bond strategy had a constantly decreasing duration within each 5-year cycle, unlike the fund which maintains a more consistent intermediate duration. Furthermore, our assumption of reinvesting coupons at the original bond rate is a simplification; actual reinvestment rates would have varied.
2. Fund Efficiency: Bond funds reinvest coupon payments and maturing principal more frequently and potentially at more opportune prevailing rates than an individual manually rolling over bonds every five years. Funds operate at scale, capturing yields continuously.
3. Duration Management: VFITX aims for an average duration (currently 5.28 years). While our comparison used 5-year notes, the fund holds a mix (5-10 years). This professional management of duration and yield curve positioning can add (or detract) value compared to a simple rollover strategy.
4. Market Timing/Reinvestment Luck: The specific dates chosen for rolling over the individual bonds (2005, 2010, 2015, 2020) locked in specific rates. The fund, reinvesting continuously, might have benefited from capturing different, potentially higher average rates over the entire period.

While the expense ratio is a drag on fund performance, this example demonstrates that it's not the only factor influencing long-term returns. The operational efficiencies, reinvestment strategies, and duration management of a fund can sometimes overcome the fee disadvantage compared to a simplified individual bond strategy, especially one requiring manual intervention.

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But I’ve Been Burned In the Past!

Okay, so even though the math above shows the bond fund potentially delivering a better return over this specific 20-year stretch, I still often hear from clients that they feel they've been "burned" by bond funds. If the fund actually grew more, why the bad feeling?

I have a strong hypothesis: it boils down to how brokerage accounts typically display your returns. When you log in, brokerage statements often break down your holdings based on when you bought them (each purchase lot). Your big initial investment shows up as one line. Then, if you're reinvesting dividends, those often appear as a long, long list of smaller, separate purchases underneath the original one.

Now, here's the rub: If interest rates generally rose during the time you held the fund (as they did dramatically near the end of our 20-year example period), the share price or NAV of the fund might be lower on a given day than when you first bought it.

Let's revisit our VFITX example to see how this plays out on the statement:

• April 1, 2005: You purchased 9,057.97 shares at $11.04 per share, for a total value of $100,000. That's your original cost basis for that specific lot. Your brokerage statement keeps that line item separate, always referencing that initial purchase.
• Fast forward to March 31, 2025: On that date, the share price was $9.92.
• The Statement View (for the initial lot only): Looking just at that original line item, the calculation would be 9,057.97 shares * $9.92/share = $89,855.06. Right next to that, you'd likely see a gain/loss column showing ($10,145) – probably highlighted in scary red text!

Seeing that apparent loss on the initial investment makes the client feel like they've lost money holding this fund! They forget, or it's not immediately obvious, that the actual positive return and the final $178,278 value we calculated came overwhelmingly from that long, long list of reinvested dividend transactions buying additional shares over the 20 years.

As we worked out earlier, going through the math to calculate the true total return, factoring in every reinvested dividend at varying share prices, is genuinely difficult without meticulous tracking (like that magnificent spreadsheet!).

I suspect this common way brokerage statements display information – focusing on the initial purchase price of specific lots rather than total accumulated value and return – is a major reason why many bond fund investors feel like they have been "burned," even when their investment has performed as expected or even outperformed simpler strategies.

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Conclusion: Making the Right Choice for Your Treasury Allocation

Choosing between individual Treasury bonds and Treasury bond funds boils down to understanding the core trade-offs. Individual bonds provide unmatched certainty if held to maturity, eliminating guesswork about your return, but they demand your active management for reinvestment. Bond funds offer convenience, diversification, and liquidity, automatically handling reinvestment, but come with fluctuating values (NAV), expense ratios, and the potential for misleading "paper losses" on brokerage statements that don't reflect the true total return from reinvested dividends.

Our 20-year analysis showed that a fund can outperform a simple individual bond strategy, even with fees, highlighting the impact of factors like reinvestment efficiency. However, the primary takeaway isn't just about potential returns or fees. It's about aligning your choice with your specific needs:

• Do you prioritize absolute certainty for a specific future date?
• Is hands-off convenience and liquidity more important?
• How comfortable are you with seeing potential short-term dips in value on your statement, even if the long-term total return is positive?
• How much time and effort are you willing to dedicate to managing your bond holdings?

Navigating these questions and understanding how your fixed-income strategy fits within your overall financial plan can be complex. At Purpose Built, we specialize in helping clients weigh these kinds of trade-offs. We go beyond simple projections to ensure your investment decisions truly align with your long-term goals, risk tolerance, and personal financial well-being.

If you're grappling with how best to structure your investments, let's talk. Schedule a free, no-obligation meeting today to see how Purpose Built can help you navigate these situations with clarity and confidence.

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Frequently Asked Questions (FAQ): Treasury Bonds Funds vs Individual Bonds

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Q1: Are individual Treasury bonds safer than Treasury bond funds?

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A1: The underlying bonds (U.S. Treasuries) are considered equally safe, backed by the U.S. government. However, the investment experience differs. Individual Treasury bonds guarantee your principal back at maturity. Treasury bond funds do not have a maturity date, and their share price (NAV) fluctuates daily with interest rates, meaning your principal value isn't guaranteed at any given moment before selling, even though the fund holds safe Treasuries.

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Q2: Do Treasury bond funds always have lower returns than individual bonds because of fees?

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A2: Not necessarily. While expense ratios do reduce a fund's net return compared to holding bonds directly with no fees, other factors matter. Our 20-year analysis (2005-2025) showed the VFITX Treasury bond fund actually outperformed a comparable strategy of rolling individual 5-year Treasuries (2.93% vs 2.11% CAGR), even after accounting for its 0.20% fee. This could be due to more efficient reinvestment, professional duration management, or specific market conditions during the period. Fees are a consistent drag, but not the only determinant of final return.

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Q3: Why can my Treasury bond fund lose value if Treasuries are so safe?

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A3: The fund's value (NAV) is based on the current market price of the bonds it holds, not their face value at maturity. When interest rates rise, existing bonds with lower rates become less attractive, so their market price falls. This causes the fund's NAV per share to decrease, showing a "paper loss" even though the underlying Treasury bonds themselves are not defaulting. Market sentiment can also impact the fund's traded price.

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Q4: For long-term investing, is it better to choose Treasury bond funds vs individual bonds?

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A4: There's no single "better" answer; it depends on your priorities. Individual bonds offer certainty if held to maturity but require active management. Treasury bond funds offer diversification, liquidity, and convenience but have NAV volatility and fees. As our analysis showed, funds can sometimes outperform over long periods despite fees due to efficiency gains. Consider your need for predictability, your tolerance for price fluctuations, and how much effort you want to put into managing reinvestments.

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Q5: What are the main advantages of Treasury bond funds compared to buying individual Treasury bonds?

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A5: Key advantages of Treasury bond funds include instant diversification across many bonds, easier liquidity (buying/selling shares daily), automatic reinvestment of interest and principal, professional management (maintaining target duration), and often lower transaction costs for buying/selling bonds due to institutional scale compared to retail investors buying smaller lots.

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Final Thoughts

Choosing between individual Treasury bonds and Treasury bond funds is a critical decision for your portfolio with trade-offs that go beyond simple returns. While bond funds offer convenience, the path isn't always straightforward, and the best approach requires careful analysis tailored to your unique financial situation and goals.

Don't navigate this complex decision alone. Let's discuss how your fixed-income strategy fits into your comprehensive financial picture. Purpose Built is here to help. Schedule a free, no-obligation meeting today to discover how we can help you achieve your financial goals and make 2025 your most financially secure year yet. Let us guide you towards smarter decisions.

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About the Author

Sean Lovison, CPA, CFP®, is a fee-only financial planner based in Moorestown, New Jersey, serving clients virtually nationwide. After spending 14 years as a corporate chief financial officer (CFO), receiving and designing compensation plans, he decided to help others navigate their plans.

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