For the better part of 15 years, bonds, also known as fixed income, didn’t offer portfolios a great deal. With interest rates as low as they were, bonds provided no yields and were a poor source of income. But since the Federal Reserve kicked off an aggressive campaign last year to raise interest rates, bonds have come back in a big way, with yields higher than they’ve been in years and providing investors with income again. So, with bonds now back in favor, it may be a good idea to look into bond ETFs and how they can fit into an investor’s overall portfolio.
Bond issuers, which range from corporations to governments, are looking to raise money. When an investor buys a stock, they’re buying a piece of ownership into a company. When buying a bond, however, the investor is lending the issuer money, which the issuer agrees to pay back, plus interest.
Unlike stocks, bonds issued by companies don’t provide ownership rights. So, while a fixed income investor won’t benefit from the issuer’s growth, they also won’t take as big of a hit if the issuer faces hardships (provided it can still stay current on its loans).
Bonds also have different maturity dates ranging from a few months to many years. The longer the duration, the riskier the bond, since it’s tough to know what the economy will look like five, 10, or 20 years from now. Long-term bonds tend to pay a higher interest rate because the bond holder is more exposed to interest rate and inflation risks.
Bond ETFs invest in fixed income securities with different strategies and holding periods. They’re available for a variety of bond categories, including Treasuries, corporates, convertibles, and floating-rate bonds, and with an array of maturities. So, for example, an investor can target a basket of short-duration corporate bonds through a fund like the Vanguard Short-Term Corporate Bond ETF (VCSH ), or if they’d prefer investing in long-term Treasury bonds, they can target a fund like the Vanguard Long-Term Treasury ETF (VGLT ).
The key advantages to bond ETFs are twofold: They offer a stream of income and offset some of the volatility from stocks. Another advantage is that passively managed bond ETFs are usually very inexpensive relative to equity ETFs or mutual funds. The largest bond ETF as measured by assets under management, the Vanguard Total Bond Market ETF (BND ), for example, has an expense ratio of just three basis points.
“Most investors should have some funds allocated to bonds,” according to Investopedia. “Bond ETFs tend to be more liquid and cost-effective than bond mutual funds, and offer diversified bond holdings across a range of bond types, from U.S. Treasuries to junk bonds.”
For more news, information, and analysis, visit the Fixed Income Channel.