Aja McClanahan is a personal finance writer who has a story of getting out of over $120,000 in debt. She's been featured in Yahoo! Finance, MarketWatch, U.S. News and World Report, Kiplinger and has written for publications like Business Insider, Credit Karma, Inc., and many others. Aja writes about investing and personal finance for Wealthsimple. In her spare time, she manages her own investment portfolios for herself, husband, and two kids. Aja double majored in Spanish and Economics and holds a Bachelor of Arts degree from University of Illinois at Urbana-Champaign.
Like exchange traded funds, or ETFs, based on stocks and indices, bond ETFs give you the opportunity to invest in a variety of bonds while adding an additional stream of income to your bottom line.
Adding bond ETFs is an option for your investment portfolio but remember, as with any kind of self directed trading there’s a risk that your investment portfolio could rise or fall. You’ll have to decide what bond ETFs are best for you (if any). We’ve put together a list of options you could choose from. The best bond ETFs (like any investment) depend on your own financial circumstances, goals and more.
Why bond ETFs?
Bonds have a regular income (via semi-annual coupon payments) associated with them. Plus, bonds are loans with a guarantee to be repaid at maturity. Bonds can help you lower your investment risk while adding to the potential to earn a return on your investment sooner than later.
It’s for this reason that many people nearing retirement more of their investments into bonds. They need more stability in their portfolio in order to buffer against the risk of having their nest egg lose value in adverse market conditions. Also, the added stream of income is a bonus for those who won’t have regular income from a job any longer.
The only problem is that buying and selling bonds isn’t the easiest undertaking in the world. Depending on the type of bond and its characteristics, buying and selling with dealers on the secondary market can be quite involved. Just trying to track and understand bond pricing means you’ll need to research things like the initial offering price, mark-ups, spread and getting the best deal in the prevailing interest rate environment.
This is where bond ETFs come in. Like indexed-based or industry-based ETFs comprised of stocks, these electronically traded funds represent a collection of bonds that trade on an exchange like a stock. The exchange helps bond buyers and sellers and interact directly (i.e. without dealers.) On the market, bond ETF prices are clearly stated so investors can find bonds at price points that work for their investing goals. The bond ETF market is a platform where bonds can be sold with relative ease making bond holdings extremely liquid.
Another benefit of bond ETFs is that they pay interest on a monthly schedule rather than a semi-annual schedule. Bond ETFs hold many bonds issued from many companies throughout the year, so the ‘semi-annual’ coupon payments can be happening throughout the year resulting in a monthly payment for the entire bond ETFs.
Short-term bond ETFs
Typically maturing over 1- 3 years, these bonds could reduce your exposure to risk (i.e. losing money) but still offer the possibility for a reasonable return on your investment. A closer maturity date means there’s less credit risk and a smaller chance of being adversely affected in the event an interest rate hike.
Here are some short-term bond ETFs to consider:
1) iShares Barclays 1-3 Year Treasury Bond Fund (SHY)
This ETF tracks the ICE U.S. Treasury 1-3 ear Bond Index. Generally considered a conservative investment, it has a relatively low expense ratio for short-term government bonds.
2) iShares Barclays 1-3 Year Credit Bond Fund (IGSB)
This ETF is based on a 1-5 Year US Corporate Index which measures the performance corporate bonds of both U.S. and non-U.S. issuers. This bond mostly features issues from companies in the financial industry or sector.
3) Vanguard Short-Term Bond ETF (BSV)
This fund tracks the performance of the Bloomberg Barclays U.S. 1–5 Year Government/Credit Float Adjusted Index which covers bonds with an average maturity of 1 to 5 years. The ETF invests U.S. government, corporate and international bonds.
High-yield bond ETFs
High-yield bond ETFs invest in corporate bonds that have a lower credit rating. These are known as below investment grade or “junk” bonds. However, the name isn’t necessarily indicative of the type of returns that can be realized with this investment. The higher-risk can offer higher returns than funds that invest in lower-yielding bonds in the government and corporate sectors.
The other side to higher returns means there’s a greater risk of default among the issuing companies. Though there are thousands of companies represented in the funds, defaults can lower the overall return on these ETFs.
1) iShares iBoxx $ High Yield Corporate Bond ETF (HYG)
The iShares iBoxx $ High Yield Corporate Bond ETF seeks to track the investment results of the Markit iBoxx USD Liquid High Yield Index, made up of high-yield corporate bonds. This fund has exposure to a broad range of U.S.-based companies. Currently, the fund has issues from almost 950 companies, many of which are in the consumer services industry or sector.
2) SPDR Barclays High Yield Bond ETF (JNK)
This actively managed bond ETF seeks to mirror the price and yield of the Bloomberg Barclays High Yield Very Liquid Index. This bond ETF aims to provide diversified exposure to high-yield corporate bonds with higher liquidity while maintaining cost-efficiency.
3) Invesco Senior Loan (BKLN)
This bond ETF is based on the S&P/LTSA U.S. Leveraged Loan 100 Index and invests 80% of its assets in securities that make up this index. In a nutshell, this fund is based on senior loans that banks make to corporations. These loans are then repackaged and sold to investors in this bond ETF.
Municipal bond ETFs
These ETF funds support infrastructure projects like building schools, highways or libraries. They’re issued by local and state governments when they need to borrow money to fund these projects. Here are some examples:
1) iShares National AMT-Free Muni Bond ETF (MUB)
This bond fund offers access to 2000+ municipal bonds. This fund seeks to track the investment results of the S&P National AMT-Free Municipal Bond IndexTM. A large part of the underlying index is represented by municipal bond issuers in the transportation and utility industries.
2) Vanguard Tax-Exempt Bond Index ETF (VTEB)
This bond ETF seeks to track the performance of the S&P National AMT-Free Municipal Bond Index. It offers diversified exposure to the investment-grade U.S. municipal bond market. The fund also offers moderate current income with high credit quality.
3) SPDR Barclays Short Term Municipal Bond (SPDR)
This fund seeks to track the performance of the Bloomberg Barclays Managed Money Municipal Short Term Index. The index contains publicly traded short-term tax-exempt US municipal bonds with a AA credit rating or better.
Corporate bond ETFs
These ETFs feature bonds issued by companies with investment-grade credit ratings. Bonds in corporate bond ETFs can be issued by corporations from varying industries.
1) iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)
These investment-grade corporate bonds are helpful for those wanting more stability in their portfolio along with income potential. This bond fund features over 1,000 high-quality corporate bonds.
2) Vanguard Short-Term Corporate Bond ETF (VCSH)
The Vanguard short-term corporate bond ETF tracks an index of fixed-rate corporate bonds with maturities between 1 and 5 years. These are investment-grade bonds that seek to provide income along with moderate price fluctuations (stability.)
3) Vanguard Intermediate-Term Corporate Bond ETF (VCIT)
This bond ETF aims to provide a moderate, yet sustainable level of income. The bond invests in investment-grade corporate bonds. This fund has a moderate interest rate risk and an average maturity of 5 to 10 years.
How do I invest in bond ETFs?
Just like stocks, mutual funds, and stock-based ETFs, bond ETFs have ticker symbols that you can use to place a trade. You can place a trade for these ETFs on pretty much any trading platform, whether browser-based or via phone app.
Before buying a bond fund, you should understand your personal financial objectives and then compare it to the bond ETF you’re considering. For example, bonds ETFs are also usually tied to an underlying index and typically seek to track the performance of that index (before fees and expenses.) Many times, a bond fund will have investments in many of the same entities that their underlying index fund have.
With this in mind, you’ll want to assess whether or not your financial goals call for a shorter investing horizon, investment-grade bonds, higher yields, etc. There are plenty of options to choose from when it comes to bond ETFs, so here are some to explore based on different investment preferences.
On a final note, in order to diversify your portfolio even more, you should consider a robo-advisor that often invests your money in stocks, bonds and real estate based on your risk tolerance. Diversity is good because it reduces your risk exposure to any one type of investment, industry etc. If you think you’d like more diversity in your portfolio, Wealthsimple can definitely help you get started.
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