What Is a Bond ETF?
Let me explain what a bond ETF is. It's an exchange-traded fund that invests only in bonds, much like a bond mutual fund but with key differences. These funds hold a mix of bonds following specific strategies, from U.S. Treasuries to high-yield options, and they vary in holding periods from short-term to long-term.
You should know that bond ETFs are passively managed and trade on major stock exchanges, just like stock ETFs. This setup adds liquidity and transparency, which helps stabilize the market during stressful times.
Key Takeaways
- Bond ETFs are exchange-traded funds that invest in various fixed-income securities such as corporate bonds or Treasuries.
- Bond ETFs allow ordinary investors to gain passive exposure to benchmark bond indices in an inexpensive way.
- Bond ETFs are available for a variety of bond categories, including Treasuries, corporates, convertibles, and floating-rate bonds.
- Bond ETFs are also amenable to laddering.
- Investors should understand the risks to bond ETFs including the effect of interest rate changes.
Understanding Bond ETFs
Bond ETFs trade all day on centralized exchanges, unlike individual bonds sold over the counter by brokers. Traditional bonds can be hard to price attractively, but bond ETFs solve this by trading on major indexes like the NYSE.
This means you get exposure to the bond market with the same ease and transparency as stock trading. They're more liquid than individual bonds or mutual funds, which only trade once a day after the market closes. Even in tough times, you can trade a bond portfolio when the underlying market isn't working well.
These ETFs pay interest via monthly dividends, and capital gains come annually. For taxes, treat them as income or gains, but tax efficiency isn't a huge deal since capital gains are smaller in bonds than stocks. You can find bond ETFs globally.
Remember, bond mutual funds and bond ETFs are similar, but their holdings and fees can differ. In 2020, U.S. bond ETFs had a record year with $168 billion in inflows. By October 2019, global bond ETF assets topped $1 trillion, and as of June 2023, they're growing fast in asset management at $206 trillion.
Types of Bond ETFs
There are various types of bond ETFs for different subsectors. For example, Treasury Bond ETFs include options like SCHO and PLW. Corporate Bond ETFs might be AGG, LKOR, or SPLB. Junk Bond ETFs are things like JNK or HYG. You also have International Bond ETFs such as BNDX or IYH, Floating Rate Bond ETFs like FLTR, Convertible Bond ETFs like ICVT, and Leveraged Bond ETFs like TMF.
If you're unsure where to start, consider total bond-market ETFs that cover the entire U.S. bond market.
Advantages and Disadvantages of Bond ETFs
Bond ETFs give you features like regular coupon payments, similar to individual bonds. A big plus is the fixed payments on a schedule, usually every six months for bonds.
But bond ETFs hold assets with varying maturities, so coupons vary monthly. The fund's assets change constantly without maturing; bonds are bought and sold as they expire or leave the target range.
The challenge for ETF creators is tracking the index cost-effectively, given low bond market liquidity. Most bonds are held to maturity, so secondary markets are thin, especially for corporate bonds over government ones.
ETF providers use representative sampling to track indexes with a subset of the most liquid bonds. This works better for government bonds, reducing tracking errors.
Overall, bond ETFs are solid for bond market exposure, but they have limits. Your principal is at more risk than with individual bonds since ETFs never mature, so no full repayment guarantee. Rising interest rates hurt ETF prices, and without maturity, mitigating that risk is tough.
Bond ETFs vs. Bond Mutual Funds vs. Bond Ladders
Choosing between bond funds or ETFs depends on your goals. For active management, go with bond mutual funds for more options. If you trade often, bond ETFs are better. For long-term holding, either works, but check the holdings carefully.
Transparency matters? Bond ETFs let you see holdings anytime. Worried about selling? Mutual funds allow redemption to the issuer. Always research and talk to your advisor.
Bond ETFs beat passively held bond ladders in liquidity and transparency. They provide instant diversification and constant duration with one trade. Ladders require buying individual bonds, lacking that ease.
Downsides of bond ETFs include ongoing management fees. Lower trading spreads help short-term, but fees erode advantages over time for buy-and-hold. Also, no flexibility for custom needs like high income or none at all—ETFs might not fit.
Frequently Asked Questions
Are bond ETFs the same as bonds? No, ETFs are pooled investments in securities. You buy and sell them like stocks, tracking bond portfolio prices.
Are bond ETFs a good investment? Most should allocate to bonds. ETFs are liquid and cost-effective over mutual funds, diversifying across types from Treasuries to junk bonds.
Do bond ETFs pay interest or dividends? They pay monthly dividends from bond interest income.
What is a bond ETF ladder strategy? It uses bonds of different maturities to cut interest rate risk, applicable to individual bonds or ETFs of varying durations.
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