If you're interested in adding some relatively conservative options to your investment portfolio, bond ladders and bond ETFs are two investment options to consider, since they can have less risk and volatility than stocks. Bond ladders involve the purchase of several bonds with varying maturity dates and interest rates. Bond ETFs invest in a portfolio of bonds that can vary by risk type, interest yield, and maturity date. Base your choice of a bond ladder or bond ETF on your individual investment goals.
Characteristics of Bond Ladders
Bond broker-dealer BondDesk Group describes bond ladders as a portfolio of individual bonds with staggered maturity dates; the various maturity dates result in a bond maturing every year. As each bond matures, you have the option of reinvesting the principal in a new bond with a longer maturity and highest return. For example, you can set up a five-year bond ladder by purchasing (in January 2013) five bonds with maturity dates ranging from January 2014 to 2018. When January 2014 arrives, the first bond matures, and the principal is reinvested into a new five-year bond. As each bond reaches its maturity date, the process continues until each bond is reinvested to ensure a consistent return every year.
Advantages and Disadvantages of Bond Ladders
Bond ladders provide predictable returns, which allow you to determine the timing and amount of the interest payments. Bond ladders also provide some protection against interest rate risk by allowing you to distribute your investment into several bonds that mature each year. At maturity, you have the option of reinvesting the bond principal into a shorter-term or longer-term bond, depending on interest rate conditions. One of the disadvantages of bond ladders is the exposure to credit risk and the possibility that a bond issuer will default on the debt. Bond ladders also provide lower returns than stock investments.
Characteristics of Bond ETFs
A bond ETF consists of a portfolio of bonds with different risk profiles, yield rates and maturity dates. A bond ETF is purchased as if it were a mutual fund traded on an exchange. A wide variety of bond ETF portfolios exists -- for example, some invest in government and corporate bonds; some invest in Treasury bonds only, and others offer protection against inflation.
Advantages and Disadvantages of Bond ETFs
Bond ETFs function in much the same way as a mutual fund, making the investment more liquid than a typical bond because you can easily buy and sell it through an exchange. ETFs are also subject to broker fees that can vary for each ETF. A bond ETF can provide a more diversified investment option than buying individual bonds. However, since a bond ETF trades like a stock, you have greater risk of losing your principal if the price drops and you are also subject to credit risk. Bond ETF investment returns tend to be lower than those offered by stocks.
