Are Fixed-Income ETFs the Right Choice for Your Portfolio?

Building a diversified portfolio of individual stocks is easier than ever, with zero-commission trades and fractional shares providing retail investors with inexpensive options. The fixed-income universe, on the other hand, doesn’t offer the same level of democratization; the typical minimum for a bond investment is around $1,000, and most bonds don’t trade in a centralized location, only over the counter (OTC).

But fixed-income ETFs solve some of the problems that have long deterred would-be bond investors. Before we look at the advantages of fixed-income ETFs, let’s start by exploring reasons why investors may want to allocate some money to bonds in general.

Key Takeaways

• Fixed-income securities like bonds are less liquid and have higher barriers to entry than equities like stocks.
• Fixed-income ETFs and mutual funds make it easier for retail traders to diversify their portfolios with fixed-income securities.
• Targeted fixed-income ETFs allow investors to target bonds with specific maturities or credit ratings.

Why Invest in Bonds?

While the stock market has historically been one of the most reliable ways to build wealth, bonds offer some unique benefits. Here are a few reasons to invest in them:

• A predictable income stream: you know exactly how much income to expect and when you will get it, provided the bond’s issuer continues to pay interest on the bond.
• Low volatility: bond values historically don’t change as much as stock prices.
• Low correlation: bonds may have a low, or even negative, correlation with other asset classes, such as stocks. When equities collapse, bonds may pick up the slack.

The interconnectedness of the global economy means that global equities are more correlated than ever. This means that investing in, say, European and Asian equities is unlikely to protect you in the event of a U.S. recession. Thus, bonds are one of the few ways to smooth out the fluctuations in your portfolio.

Important

Fixed-income ETFs offer many of the same benefits as bonds, including relatively low volatility, low correlation, and consistent income.

Fixed-Income ETFs vs. Mutual Funds

We’ve already touched on the challenges that come with investing in individual bonds; they typically only make sense if you’re okay with not being diversified and/or you have a lot of money to invest all at once.

If you are looking for diversification at a reasonable price, fixed-income mutual funds and fixed-income ETFs are two of the best options. Mutual funds might be the right option if you want a certain manager to handle your investments. But fixed-income ETFs may be the better option in other cases, as they often have much lower expense ratios than mutual funds and higher liquidity. In addition, ETFs provide investors with portfolio transparency so you know what you have exposure to.

Consider Targeted Fixed-Income ETFs

With fixed-income ETFs, the good news is that you can take a targeted approach, investing in different types of funds. For example, you can choose between a short and long-term bond fund or specify the credit quality of your investments. The benefit of this approach is that you can alter your strategy based on market conditions, or efficiently fill gaps within your existing portfolio. 

Do you think that interest rates are going to soar over the next several years? Perhaps you want to keep your fixed-income allocation in short-term bonds or floating rate notes. Or maybe you think that offerings with a higher credit quality are set to outperform and you want to tilt your portfolio in that direction. Whatever the case may be, there are reasons why you would want to exercise control over your portfolio.

If you’re interested in selecting the type of bonds in your portfolio—but not having to pick the bonds themselves—you may want to look at VanEck’s municipal income ETFs. Other options include the VanEck Fallen Angel High Yield Bond ETF and the VanEck Investment Grade Floating Rate ETF. These funds not only allow you to target specific maturities and credit quality or segments of the market offering unique value, they also let you do so easily. VanEck offers experience in the fixed-income space and provides key insights that can help you shape your investment strategy.

Are Fixed-Income ETFs Illiquid?

Fixed-income ETFs are more liquid than the bonds and other fixed securities that underly these ETFs. In fact, in volatile markets or fixed-income selloffs, liquidity for fixed-income ETFs can increase even as liquidity for the underlying bonds decreases.

Do Fixed-Income ETFs Pay Dividends?

Fixed-income ETFs pay interest, not dividends, although the result is essentially the same. Those ETFs that pay interest do so on a monthly basis based on the interest generated from the underlying bonds in the ETF.

What is a Fixed-Income ETF Ladder Strategy?

A fixed-income ETF ladder strategy uses fixed-income ETFs with different bond maturities to reduce interest rate risk. This is done by purchasing ETFs with bonds that have different maturities.

The Bottom Line

The fixed-income market has traditionally been less accessible than the stock market, but times are changing. With ETFs offering diversification and liquidity at a low cost, the fixed-income market is becoming more accessible to all. By investing in targeted fixed-income ETFs, you can select investments that fit your exact requirements—without having to spend countless hours doing deep research on individual bonds.

DISCLOSURES

This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.

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