Investment in Bond ETFs: Fortifying Portfolios with the Secure Base of Bond ETFs
Bond Exchange-Traded Funds (ETFs) are a popular investment choice for those seeking manageable risk and regular income. These fixed-income securities give you the right to repayment, making them an attractive option for investors.
One crucial factor to consider when choosing a bond ETF is the Tracking Error, which describes the difference between the performance of the ETF and the actual development of the index course. Bond ETFs strive to track an index as closely as possible.
The risk of investing in bond ETFs is significantly lower than that of investing in stock ETFs, but it increases when investing in bonds from less financially stable countries. During the stock market crash caused by the Corona pandemic, bond ETFs remained stable, while stock ETFs fell significantly.
Bond ETFs can be government bond ETFs, but banks and companies also issue bonds, so you can also buy corporate bond ETFs. The key differences in yield and risk between government bond ETFs and corporate bond ETFs stem mainly from the credit quality and default risk of the underlying bonds.
Corporate bond ETFs generally offer higher yields to compensate for the increased risk of default. Government bond ETFs, on the other hand, typically offer lower yields as they invest in government debt, which is considered safer.
Government bond ETFs are considered low risk due to their lack of credit risk, offering greater capital preservation and portfolio stability. In contrast, corporate bond ETFs carry higher risk due to the chance of issuer default and greater sensitivity to economic conditions.
When deciding on a bond ETF, investors should consider factors such as the yield, type, creditworthiness, maturity, Total Expense Ratio (TER), payout type, and size of the fund's assets.
Bond ETFs can be replicated using two methods: physical replication and synthetic replication. Buying Bond ETFs is as easy as buying other ETFs, through a securities account.
A new type of bond ETF, iBond ETFs, combines the characteristics of classic index funds with those of individual bonds, offering predictability and risk diversification. However, these ETFs contain bonds from companies with medium credit quality, which carries a higher default risk than government bonds from countries with the highest credit rating.
Another risk associated with bond ETFs is that their value decreases when interest rates rise. Inflation-protected bond ETFs, which make an inflation bet and whose performance depends on inflation expectations, can be complex financial products that may be difficult for beginners to understand.
In summary, if your priority is safety and stability, government bond ETFs are generally better. However, corporate bond ETFs can provide higher income at the expense of higher credit risk. Investors often balance both types in a portfolio based on their risk tolerance and income needs.
[1] Investopedia. (2021). Bond ETFs. Retrieved from https://www.investopedia.com/terms/b/bondetf.asp [2] The Balance. (2021). Bond ETFs: An Introduction. Retrieved from https://www.thebalance.com/what-is-a-bond-etf-354000 [3] Nasdaq. (2021). iShares U.S. Treasury Bond ETF (GOVT). Retrieved from https://www.nasdaq.com/symbol/govt/real-time [4] BlackRock. (2021). iShares iBond ETFs. Retrieved from https://www.ishares.com/ie/products/266659/ishares-ibond-us-treasury-index-etf [5] Schwab. (2021). Bond ETFs: Pros, Cons, and How They Work. Retrieved from https://www.schwab.com/resource-center/insights/content/bond-etfs-pros-cons-and-how-they-work
After considering the risk-reward trade-off, some investors may choose to fix their investments in corporate bond ETFs for higher yields, understanding the increased risk due to the chance of issuer default and greater sensitivity to economic conditions. Conversely, those prioritizing safety and stability might opt for government bond ETFs, which offer greater capital preservation and portfolio stability, due to their lack of credit risk.
