- A number of cheap, easy-to-use bond ETFs are available to average retail investors
- Fixed-income market does not have the level of liquidity that most stock investors are accustomed to
- On the other hand, fixed-income investors may turn to bond ETFs, which track a portfolio of bonds and are traded on an exchange like a stock
Investors who are seeking a balanced and diversified investment portfolio will likely include some fixed-income assets in the mix. However, debt securities are more difficult for most to to acquire, but luckily for the average retail investor, there are a number of cheap, easy-to-use bond exchange traded funds to choose from.
“Having any percentage of bonds in your portfolio, 40 percent or otherwise, is a good idea because bonds can help provide income and some stability,” writes Matt Tucker, head of iShares Americas Fixed Income Strategy at BlackRock, for CNBC. “There are a wide variety of investments that we can use to fill the space, but some investments are going to be more efficient than others.”
To get a sense of how debt securities are traded, individual bonds are bought and sold over the counter. In the OTC market, there is no exchange, so buyers and sellers will have to negotiate a price. If an investor is interested in a bond, you would have to contact individual bond dealers and find one that’s willing to sell.
Consequently, the fixed-income market does not have the level of liquidity that most stock investors are accustomed to. Individual bonds can be hard to track down and quotes can widely vary, so it is difficult to efficiently price the securities.
On the other hand, fixed-income investors may turn to bond ETFs, which track a portfolio of bonds and are traded on an exchange like a stock.
“You see the price at which you can buy and sell the ETF, allowing you to better make an informed decision about your bond investment,” Tucker said.
Investors have a number of bond ETF options available at their fingertips. Some bond ETFs target specific areas like corporate debt, U.S. Treasuries and specific credit ratings or maturities while others may include broad diversified portfolios of almost everything.
Additionally, with bond ETFs, investors will enjoy diversification as many funds hold hundreds if not thousands of individual bond securities, something that would be hard to achieve on one’s own.
While most bond ETFs passively track a benchmark index, there is still a management component in the way the funds are run. Tucker points out that a portfolio manager must build and maintain a portfolio that seeks to track the index with the securities available, but some securities are thinly traded or illiquid. If the PM is doing his or her job correctly, the ETF will closely track the underlying index.
Tucker also warned of some fallacies associated with going the individual debt securities path. For instance, some investors assume that buying a bond security is basically free since one just trades it at a price. However, Tucker pointed out that there can be fairly hefty transaction costs that are baked into the asking price. Standard & Poor’s estimates that investors pay a 1.27% transaction cost when acquiring municipal debt and costs for other fixed income sectors are similar.
In contrast, passive bond ETFs have an average 0.35% expense ratio, according to XTF data. Investors would only have to worry about the brokerage commission fees on ETF trades, like stock trades, but there are some brokerage platforms that offer commission free trades.