Bond ETFs are an example of how a simple, sensible investment can get complicated in a flash.
A reader reminded me of this with a recent query. “I’m selling some equity ETFs and buying bond ETFs. Do you suggest one that focuses on long or short term bonds?”
What I suggest is that this person research a broad, all-in-one bond exchange-traded fund, like the BMO Aggregate Bond Index ETF (ZAG), the iShares Core Canadian Universe Bond Index ETF (XBB), the TD Canadian Aggregate Bond Index ETF (TDB) or the Vanguard Canadian Aggregate Bond Index ETF (VAB).
When you buy ETFs like these, you’re buying the entire bond market in a single go. Short-, medium- and long-term bonds, corporate and government, federal and provincial. Blended together into a benchmark like the FTSE Canada Universe Bond Index, these various bonds produce an after-fee yield to maturity of around 2 per cent (yield to maturity, or YTM, is the best measure of a bond ETF’s yield). Management-expense ratios for broad bond ETFs are in the 0.09 to 0.1 per cent range, which is quite reasonable.
A more defensive approach would be to buy a short-term bond ETF, which holds bonds maturing in five years or less. Short-term bonds are more resilient in a rising-interest-rate environment, but the yields are kind of thin. A higher-yielding long-term bond ETF (holding bonds maturing in 10 years or longer) would be an aggressive, speculative move designed to capitalize on falling rates. If rates were to rise, long-term bonds would plunge in price.
Holding a broad-market bond ETF means you’re positioned somewhere between the low-yield, lower-risk profile of short-term bonds and the high-risk, high-reward profile of long-term bonds. For a long-term investor who is more concerned with growth than capital preservation, this makes sense.
One last thought: Consider guaranteed investment certificates as a bond ETF alternative. GICs are illiquid, while bond ETFs are the picture of liquidity in that you can trade them any time during market hours. The reward from GICs is somewhat higher yields than bond ETFs – if you use alternative banks or credit unions – and zero volatility. GICs don’t change in price as rates rise and fall; you just buy them and hold until maturity.