Fixed-Income Investing: The ETF Approach
Fixed-income exchange-traded funds (ETFs) are bond index funds that are listed on a stock exchange and trade throughout the day. There are fixed-income ETFs that focus on corporate, government, municipal, international, and global debt, as well as funds that track the broader Barclays Aggregate Bond Index.1 In addition, investors may purchase bond ETFs that focus on specific maturities or sections of the yield curve.
Like mutual funds, fixed-income ETFs provide a convenient way to diversify; instead of purchasing a series of individual bonds, an investor may enhance fixed-income holdings with one transaction. Another similarity is that bond ETFs often pay regular interest but do not have a specific maturity date. Investors do not own the underlying securities but instead hold shares in a pooled investment.
Fixed-Income ETFs vs. Mutual Funds
Despite their similarities, there are also key differences between bond ETFs and mutual funds. When investors purchase or sell shares in an ETF, they are required to go through a broker and pay a commission as they would when trading a security. With a fixed-income mutual fund, depending on how a particular fund is marketed, investors may purchase or redeem shares by contacting a fund firm directly or by working with a financial advisor.
| Fixed-Income ETF | Fixed-Income Mutual Fund | |
| Net Asset Value | May be higher or lower than the price at which the fund trades. | Is identical to the share price. |
| Trading and Pricing | Traded and priced throughout the day, like a stock. | Priced once a day after market close. |
| Management | Most are passively managed, tracking an index. | Most are actively managed. |
| Shareholder Reporting | Holdings are disclosed daily online. | Rules require holdings to be reported semiannually, although many firms disclose them more often. |
| Liquidity | May be traded throughout the day. May use margin, sell short, and trade options. | Although customers may place orders throughout the day, the orders are not filled until after the 4 p.m. market close. Most funds have rules prohibiting frequent trading. |
| Expenses | Investors pay brokerage commissions when buying or selling shares. Annual expense ratio typically is less than that of a mutual fund.2 | Many firms impose redemption fees, 12b-1 fees, or sales loads. |
Fixed-Income ETFs vs. Individual Bonds
Like mutual funds, fixed-income ETFs differ from individual bonds in that they are pooled investments and offer diversification. Other differences include:
| Fixed-Income ETF | Individual Bonds | |
| Structure | Pooled investment of multiple bonds, offering diversification. | Single security tied to specific issuer. |
| Trading and Pricing | Traded and priced throughout the day, like a stock. | Bought and sold through broker bond desk. Secondary markets generally less liquid. |
| Interest Rate Sensitivity | Prices vary inversely to changes in market rates. | If held to maturity, no interest rate risk. If sold prior to maturity, prices will vary with changes in rates. |
| Expenses | Investors pay brokerage commissions when buying or selling, and annual fund expenses apply. | Brokerage commissions are included in bond price. |
Whether used as the core of a fixed-income portfolio or in combination with mutual funds and individual securities, bond ETFs offer many benefits for fixed-income investors. Talk to your financial advisor to learn more about how fixed-income ETFs might work in your portfolio.
1Investors in international securities are sometimes subject to somewhat higher taxation and higher currency risk, as well as less liquidity, compared with investors in domestic securities. Holdings in municipal bond funds may be subject to the federal alternative minimum tax. Capital gains on the sale of fixed-income securities are taxable for federal and in many cases, state purposes.
2Source: NYSE Alternext US (formerly American Stock Exchange).
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Post by Phil Ratcliff
Phil Ratcliff, President of rebel Financial, is a senior financial advisor that holds an AIF®, CFP®, ChFC®, and CLU® certifications. He started his career at American Express Financial Advisors in 2003, then moved to AXA Advisors for 7 years before founding rebel Financial LLC in 2013.
