The Bond ETF is regarded as an efficient and affordable way to access different types of corporate and government bonds. Like other investment products, bond ETFs have risks and rewards. But lately, investors have been pouring much more cash into bond ETFs. Trim Tabs Investment Research reports that $16 billion was pumped into U.S. government bond ETFs during the month of February. Bond ETFs attract investors because they are liquid, easy to access and use, and have low trading costs. Interested in learning more about ETFs? Check out the Basics of ETF Investing.
What Are Bond ETFs and How Do They Work?
When you buy bonds, you are essentially lending money to a corporation, government or municipality that sells those bonds. The organization that sells the bond promise to repay your principal when the bonds mature plus a rate of interest based on the duration of your investments.
Bond ETFs are exchange-traded funds that invest in bonds only. When you participate in a bond ETF, you can only buy from other investors rather than companies that hold ETFs. Similar to mutual bonds, bond ETFs put together bond portfolios and device strategies to trade on the exchange markets. Bond ETFs aim to afford investors investment products that are both liquid and tax efficient.
Like other exchange-traded funds, bond ETFs work by tracking the underlying bond index. Interest is paid out in the form of monthly dividends, but gains on capital is paid annually. Because bond exchange-traded funds are managed passively, investors pay low managerial fees.
Bond ETFs Categories
There are different types of bond ETFs which includes “mortgage-backed bonds”, “inflation-protected bonds”, “long-term bonds”, “mid-term bonds”, “short-term bonds”, “corporate bonds”, “U.S. Treasury bonds”, “convertible bonds”, “inverse bonds”, “international bonds”, “municipal bonds”, “leveraged bonds”, “junk bonds” and “leveraged bonds”.
There are other different types of bonds than mentioned above, as well. But, all bond ETF types on the market fall under one of the three categories below.
1) Corporate Bond ETFs
Corporate bond ETFs focus their investments in “investment grade corporate bonds”. If you are prepared to take greater risks, to gain greater greater returns, corporate bond ETF would be appropriate.
2) Government Bond ETFs
U.S Government bond ETFs focus their investments in US Treasury bonds only. Government bonds are suitable for investors prepared to take minimal risks only.
3) Municipal Bond ETFs
Municipal Bond ETFs are issued by states or cities and focus primarily on municipal bonds. Investors falling under the high tax group would find these bonds profitable. This is because municipal bonds incomes are steady and exempted from tax deductions.
Advantages and Disadvantages
Since ETFs can be traded like stocks, they are easy to exchange for cash at any time. This provides an opportunity for investors who may wish to take advantage of aggressive day traders. Perhaps what attracts most investors to bond ETFs is that these financial products expose them to many investment opportunities. They can choose between long, short and medium term investments. There are also many different types of bond ETFs investors can choose from.
The problem with bond ETFs is that they never mature, and they are easily impacted by the interest rate movements. The bond ETF value can only increase when the interest rate decreases. Hiking interest rates will decrease the fund value. The risks are highly dependent on the funds in your portfolio. Some ETFs are more volatile than others. But, just like any other investment product, there’s generally no yield guarantee. However, investing is the only way to reap a reward.
Five Most Popular ETFs
There are many bond ETF types and more entries are expected. The list below is comprised of the five most popular funds.
1) BMO Aggregate Bond Index ETF (ZAG-T)
ZAG-T has more than $700 million in assets. This ETF consists of a mixture of corporate and government bonds. It is most preferred by investors because it is budget-friendly.
2) BMO High Yield U.S-Corporate Bond Hedged to CAD Index ETF (ZHY-T)
ZHY-T has more than $600 million in assets. This fund is the biggest iShare competitor. However, it differs from iShare because it has 299 holdings while iShare has 781 holdings.
3) BMO Mid Corporate Bond Index ETF (ZCM-T)
ZCM-T has more than $500 million in assets. Participants choose between long-, short- and mid-term corporate and government bond ETFs. Long term ETFs are vulnerable to interest rate movements, while short term ETFs are rather defensive.
4) BMO Short Corporate Bond Index ETF (ZCS-T)
ZCS-T has over $6oo million in assets. This ETF is suitable for conservative investors looking for corporate bonds that have the highest chance to perform better than government ETFs when the interest rate rise.
5) Horizons Active Corporate Bond ETF (HAB-T)
HAB-T has over $400 million in assets. This fund is more costly to own.
When you choose ETFs, think about the yield. The best way to accurately calculate the yield is to look at the investment return after maturity fees. Do not get carried away by high yields and forget about investing safety. Before you invest, you must know what you stand to lose and what you stand to gain.
The ETF industry can be overwhelming. There are many products on the market hence it is not that easy for investors to pick two or three great ETFs to add to their portfolio. You should expect to find both good and bad ones. To avoid unnecessary risks, you should pick ETFs that correspond to your personal risk-reward profile. Investors are also advised to learn about different bond ETFs and how they are likely to perform in varying economic conditions and interest rates.
Investing is meant to help you save and increase your wealth. It can be a boon, especially if you need and want an additional flow of income. Nonetheless, it is crucial to understand the basics as is offered by this Udemy course, Investing Fundamentals. If you want to boost your portfolio even further, check out this Udemy course, Creative Real Estate Investing & Flipping Houses. Moreover, you can learn more about investing with this blog, 5 Best Ways to Invest $10,000 and 5 Worst Ways.