Monday Nov 27 2023 07:58
10 min
Bond ETFs are a type of investment that can add diversification to your trading portfolio, potentially reducing your overall risk exposure. This asset class also can offer attractive yields, offering a steady stream of revenue for investors and traders. Depending on your financial goals and strategies, bond ETFs may be a valuable addition to your acquisitions.
Get a head start on bond ETFs with this comprehensive guide. Understand the basic concepts, including the types of bonds, benefits, risks, and strategies.
Bond ETFs are a type of exchange-traded fund that invests in bonds. Like regular ETFs, bond ETFs track an underlying index and trade on major stock exchanges. The portfolios of bond ETFs contain various types of bonds, such as government bonds, corporate bonds, municipal bonds, and more.
Bond ETFs provide an easy and low-cost way for investors and traders to gain diversified exposure to many different bonds in a single fund. It also holds baskets of hundreds or even thousands of bonds, just like bond mutual funds. However, unlike mutual funds, bond ETFs trade intraday on stock exchanges, providing continuous pricing and the ability to buy and sell anytime the market is open.
There are many varieties of bond ETFs available to suit different traders’ needs:
Several advantages make bond ETFs an appealing investment for many investors and traders:
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While bond ETFs have many positive attributes, there are some risks and considerations to keep in mind:
The prices of bonds move inversely to interest rate changes due to their fixed-income nature. When interest rates rise, the prices of existing bonds fall to match the yields of newly issued bonds in the rising rate environment. The longer the bond maturity, the more sensitive the price is to rate changes. Bond ETFs with longer duration feel a greater impact when rates rise. For example, a 1% rate increase can cause a 25+ year Treasury bond ETF to fall by 20% or more. Being mindful of duration and managing interest rate exposure is crucial for bond ETF investors.
The credit quality and default risk of the underlying bonds are key risk factors. Bond ETFs holding investment-grade corporate and government bonds have minimal credit risk. However, those holding high-yield junk bonds have a greater risk of defaults, which can reduce income and principal. Individual bond defaults may not significantly impact diversified bond ETFs. But major downgrades and waves of defaults during recessions do affect overall returns. Choosing ETFs with higher-quality bonds can mitigate credit risk.
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Since bond ETFs aim to match index returns, not outperform, there will be some tracking errors. The ETF’s fees and expenses will cause a slight performance lag versus the index. Also, bond ETFs use sampling strategies to mimic indices rather than owning all the securities. This can lead to small performance deviations. Tracking error is usually minor, but investors should be aware.
Investors have less control over the specific bonds and individual weightings held in a bond ETF than trading individual bonds or actively managed funds. You must accept the ETF’s particular portfolio and weights. Some bond ETFs are highly diversified, while others target specific sectors, so customisation ability varies. Investors seeking more control can combine ETFs with individual bonds.
Bond ETF shares can be bought and sold easily on exchanges. However, some segments of the fixed-income market, like high-yield bonds, can become less liquid during periods of market unrest. This lack of liquidity in the underlying bonds can lead to larger bid-ask spreads and premium/discount pricing for the ETF.
Like most ETFs, bond ETF distributions are taxed as income rather than the more favourable long-term capital gains rates. However, interest income from government and municipal bond ETFs is exempt from federal and state taxes, respectively. So, bond ETFs can fit well in tax-exempt retirement accounts or taxable accounts per the type of income.
Bond ETFs can be utilised in various ways within investment portfolios:
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Bond ETFs have become a mainstream staple in investor portfolios due to their inherent benefits like low cost and diversification. They allow small and large traders to have easy access to the huge and diverse bond market.
However, bond ETFs do carry risks like interest rate sensitivity, credit risk, and tracking deviation that should be evaluated. Overall, bond ETFs can be useful for passive core holdings, tactical shifts, accessing specific niches, and completing a fixed-income allocation. As with any investment, they should be researched carefully and used prudently within a balanced portfolio. Bond ETFs simplify investing in bonds while providing flexible exposure.
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When deciding to trade bond ETFs, a CFD trading calculator will make calculating your hypothetical P/L (aggregated cost and charges) easier. Using our calculator, you can quickly evaluate any position you hold or are about to open by calculating its spread, margin requirement, overnight swap and more.
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When considering “CFD bond ETFs” for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice."