Should You Have A Bond Fund Or Bond ETF In Your Portfolio?
“Both bond funds and bond exchange-traded funds (ETFs) invest in baskets of bonds or other debt instruments. Bond funds consist of pools of capital from investors and have a manager who decides where to invest. Bond ETFs consist of an index of bonds whose goal is to match the returns from an underlying index.” George Politarhos
Depending on your risk tolerance and goals, you may be considering either a bond fund or an ETF to your investment portfolio. Investing in single bonds is another choice but is typically more challenging for individual investors.
Should you choose a bond fund or a bond ETF?
If you invest long-term and prefer more active management, bond mutual funds offer more options than ETFs. If you like buying and selling frequently, bond ETFs might make more sense. For long-term, buy-and-hold investors, it’s possible that either bond mutual funds or bond ETFs could meet your needs.
Transparency is another factor to consider. Bond ETFs let you see the fund’s holdings at any given moment. However, if being able to sell quickly, if needed, is essential to you, then a bond fund might be better, That’s because, unlike ETFs, which can only be sold if there are buyers in the market, a bond fund lets you sell your investment back to the fund’s issuer.
Because their portfolios hold a variety of bonds, both ETFs and bond funds offer degrees of diversification. Due to smaller investment minimums, you achieve diversification with less cash than you would need to achieve the same levels when purchasing individual bonds. Bond funds and bond ETFs are also generally less volatile than stocks and other securities.
Lower risk is one reason seniors within a few years of retirement may add them to their portfolios.
There are, however, potential downsides of ETFs and bond funds, including:
- You aren’t guaranteed to get your principal investment back. Bond ETFs never mature, so they do not offer the same protection for your initial investment the way that individual bonds or safe money products like annuities can. There is no guarantee of principal with an ETF. However, a few ETF companies have started issuing exchange-traded funds with specific maturity dates. This type of ETF works by holding each bond in the portfolio until it expires and then distributing the proceeds once all the bonds mature.
- You could potentially lose money if interest rates rise. When interest rates fluctuate over time, the value of bonds may fall. Selling those bonds could result in losing money on your initial investment. Since most bond ETFs do not mature, there’s little you can do to avoid raising rates.
- Both bond funds and bond ETFs have fees. Although ETFs typically have lower costs than their bond fund counterparts, there are still fees associated with having either of these products. These costs can add up over time, impacting your gains.
While you are researching the pros and cons of bond funds and bond ETFs, you might also want to take a look at fixed-indexed annuities. These types of safe money products are somewhat like bond funds in that they offer market gains with less downside risk. Unlike most bonds and bond ETFs, however, many fixed annuities have no fees at all.
Annuities may be an attractive alternative to bond funds for some investors because they can:
- Protect your nest egg from market declines.
- Eliminate the risk of bond default.
- Allow you to make gains when there is positive performance of stock market indexes
- Offer tax-advantaged saving that allows your money to grow tax-free until you make withdrawals.
- Create predictable, sustainable lifetime income by adding a lifetime income rider
Summing it up: Bond funds and bond ETFs can assist in helping diversify your portfolio and are typically less risky than stocks. However, there are numerous pros and cons to research before adding them to your retirement portfolio. The same applies to annuities, which some retirees prefer over bonds because they offer guarantees and customization options. Seeking the advice of a retirement and income specialist will help you decide which products are best for your unique financial situation.