Sorry, but bonds and ETFs don’t mix.
Bond ETFs are failing to mimic bond investments because they are nothing like buy and hold bond investing.
Even though your bond ETFs may have gone up with bonds, things could change as we enter what looks like a rising interest rate environment.
Consider this: When an ETF invests in stocks, those stocks retain their equity market characteristics. However, a passive bond index ETF is a much different animal than say, owning any one of its underlying bonds individually. Bonds in an ETF no longer look or act like bonds. Simply put, bonds have maturity dates, whereas indexed bond investments do not. Remember, the interest-rate risk of an individual bond will decrease as it approaches maturity. A bond ETF, on the other hand, exhibits constant interest-rate risk. With interest-rate risk at the top of mind, this can be a critical point to consider for investors.
Thus if you need bond exposure in your portfolio, it’s probably best not to use bond ETFs.
An example might help drive this point home. It is common practice for many to invest in laddered bond portfolios designed with specific maturities. This makes sense for those planning for a major event (such as buying a house) and who plan to hold until expiration and collect par on their investment (this is commonly referred to as a liability driven investment). Price swings caused by movements in interest rates might be of little concern to such investors who know they’ll receive par on their investment at maturity, as long as the creditor remains solvent.
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