I’m bullish on bonds.
Now that 0% interest rates are a thing of the past, bonds finally pay a decent amount of interest. And with the markets predicting rate cuts in 2024, you have a very good chance of earning a strong return on bonds, as their prices will rise if rates fall.
But I have a big problem with the bond industry.
It’s the way most investors buy bonds: bond funds. Since bond prices move in the opposite direction of interest rates, bond funds work well when rates are falling and the prices of the bonds in their portfolios are rising. But when rates rise, those same bonds fall in price and investors get crushed.
For example, the largest bond fund, the Vanguard Total Bond Market ETF (Nasdaq: BND), dropped from a high of $75 to $68 last year before bouncing in October as the markets began to believe rates had topped out. That’s a drop of more than 9%.
The iShares Core U.S. Aggregate Bond ETF (NYSE: AGG), another large bond fund, fell 9.5% from high to low last year.
Both of these exchange-traded funds (ETFs) are still below where they were a year ago.
The two funds have more than $200 billion in combined assets. That’s a lot of money that retail investors shelled out because they thought bonds were safe.
The thing is, bonds are safe… if you buy individual bonds rather than a fund or ETF.
When you buy a bond fund or ETF, you are at the mercy of the fund manager or the index that the bond is tied to. And if you want to withdraw some funds, you’d better pray that the price is higher than it was when you bought it. Otherwise, you’ll end up taking a loss.
But when you own individual bonds, you’re able to plan accordingly so you know when your cash will become available. If you needed your funds in October 2026, for example, you would buy an individual bond that matures before then.
Best of all, you know that at maturity, each bond is going to be worth par value (which is $1,000) no matter where it traded in the past. At maturity, you will receive $1,000 unless the company has gone bankrupt – which is extremely unlikely unless you’re buying the riskiest of bonds.
If you were to buy the iShares bond ETF I mentioned above, the price could be anywhere by October 2026. It could be at $98, which is where it’s at as I write, or it could be at $105 or $80. If you buy it at $98 and it’s at $80 when you need the money, you’ll collect only $800 for every $980 you invested.
Meanwhile, if you buy a bond that matures in October 2026 for $980 today, you will receive $1,000 in October 2026 – plus you’ll have collected interest along the way.
Wall Street makes it very easy to buy bond funds or ETFs. Buying them is just like buying stocks. It’s about as simple a process as there is.
Buying a bond is a little – but just a little – more complicated. Sometimes, there is no market for a particular bond, meaning your broker will have to work to find a buyer or seller for you. If they can’t, you won’t be able to make the transaction. For that reason, you should only buy bonds you intend to hold until maturity.
If the bond’s price climbs or you want to sell for another reason, you likely will be able to, but unlike with stocks, ETFs and mutual funds, there’s no guarantee there will be a buyer.
You can always call the fixed income desk at your broker if you ever get stuck or have questions. Most fixed income desks have very good customer service, as the representatives are usually bond specialists.
Individual bonds provide income and safety for your portfolio. Bond funds produce income only. There is no assurance that you will ever get your money back from a bond fund.
Stick with individual bonds for the fixed income part of your portfolio.