Investors can invest in bonds by purchasing bond exchange traded funds (ETFs). Like bond mutual funds, exchange traded funds comprise baskets of bonds that follow a particular investment strategy. Bond exchange traded funds may also be passively or actively managed. Exchange traded funds management fees are typically lower than both the bond mutual fund fees.
Typically, exchange traded funds are very low cost, and investors can keep more of the returns instead of paying a manager’s fees as with a mutual fund. For a newer investor or someone with less capital to invest, the threshold of entry is just the cost of the exchange traded funds instead of the initial investment minimums with many bonds and mutual funds.
Besides the lower cost, exchange traded funds offer even greater liquidity. Shares of exchange traded funds trade like stocks during regular market hours, rather than only once a day with mutual funds. Like bond mutual funds, bond exchange traded funds offer regular income payments.
A bond mutual fund might be a better choices for investors who plan on holding the fund shares for an extended period of time. More active investors might prefer bond exchange traded funds since there aren’t short-term redemption fees charged by some mutual funds to discourage excessive trading.
Bond ETFs do not mature. Individual bonds have a fixed, unchanging date at which they mature and investors get their money back; each day invested is one day closer to that result. Bond ETFs, however, maintain a constant maturity, which is the weighted average of the maturities of all the bonds in its portfolio. At any given time, some of these bonds may be expiring or exiting the age range that a bond ETF is targeting (e.g., a one- to three-year Treasury bond ETF kicks out all bonds with less than 12 months to maturity). As a result, additional bonds are continually being bought and sold to keep the portfolio’s maturity constant.
However, one of the disadvantage of the bond ETF is that you can lose money if interest rates rise. Interest rates change over time. When they do, the value of bonds may fall, and selling those bonds can lead to losing money on your initial investment. With individual bonds, you mitigate the risk by just holding on to a bond until maturity, when you’ll be paid its full face value. Bond ETFs don’t mature, however, so there’s little you can do to avoid the sting of rising rates.