The Many Uses of Bond ETFs

Whether an investor is looking for safety or a way to diversify his portfolio, bond exchange traded funds (ETFs) have become popular investment tools that have a multitude of uses.

Michael Schmidt at Investopedia lists the following ways an investor can put bonds to use:

• Preserve principal. Bonds are essentially loans with scheduled repayments and maturities, therefore making them effective at preserving principal.

• Savings. Savings bonds have been used for decades as a method to build savings and provide one of the most secure and time-tested approaches to long-term savings.  To make them even more attractive, they are guaranteed by the full faith and credit of the U.S. government

• Managing interest-rate risk. This type of risk is inherent in bonds because their value is a culmination of the present value of the future interest payments and returned principal upon maturity.  There is an inverse relationship between interest rates and bond prices.

• Expense matching/immunization. Individual investors use bonds to match a future expected cash need. Institutions use this strategy on a more complex basis, called immunization, which assumes a match of the duration of the bond to the expected cash flow, which can be accomplished by using a zero-coupon bond.

• Long-term planning. Bonds have a steady stream of income, which can be used to fund future expenses for individuals and corporate pension obligations for institutions.  This is why financial institutions use long-term bonds for long-term planning.

There are a number of bond ETFs on the market right now that suit a wide range of risk appetites and goals. One way to grab the benefits of bonds could be through a broad ETF such as the iShares Barclays Aggregate Bond Fund (AGG), which is up 1.6% year-to-date.

For more stories on bond ETFs, visit our bond ETF category.

Kevin Grewal contributed to this article.