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Bond ETF vs Bond Mutual Funds. Which is better? All you need to know
Before proceeding to the comparison between Bond ETF vs Bond Mutual Funds, let’s quickly brush up on our knowledge of bond ETFs and Mutual Funds.
Bond Mutual Funds
For many years, mutual funds have been investing in bonds. Balanced funds, including stock and bond allocations, have been around since the late 1920s.
As a result, there are many bond funds available that provide a wide range of investment alternatives.
Passively managed funds, which strive to duplicate various benchmarks while not attempting to surpass those benchmarks, and actively managed funds that seek to outperform their benchmarks are the two types of bond mutual funds available in the market.
There are two types of bond mutual funds available
Open-ended funds can be purchasable directly from fund providers. The brokerage commission cost does not exist if the item is purchased directly.
Bond funds can be redeemed by resale to the fund house, making them liquid and easy to buy and sell.
Open-ended funds are valued and exchanged once a day. Furthermore, each fund’s net asset value (NAV) is determined when the market closes.
The NAV is reflected in the trading price. Since open-ended funds do not trade at a markup or a discount, determining how much a fund’s shares will yield if sold is simple and predictable.
Daily, bond mutual funds do not disclose their core holdings. They report their holdings semi-annually in most cases, with specific funds reporting every month.
Investors cannot ascertain the specific makeup of their portfolios at any given time due to a lack of transparency.
A closed-end fund is a form of mutual fund that raises cash for initial investments by selling a limited number of shares in a single initial public offering (IPO).
Its shares can then be purchased and sold on a stock exchange, but no new shares or money will flow into the fund.
Bond ETFs
Compared to mutual funds, bond ETFs are new to the market, with iShares establishing the first bond ETF in 2002.
Although a rising number of actively managed products are available, most of these offers strive to mirror various bond indices. Ceteris paribus, ETFs often have lower fees than their mutual fund counterparts, potentially making some investors the more attractive choice.
Trading of bond ETFs on a secondary market and the provider is not involved in the day-to-day transactions of the investors. ETFs are traded continuously throughout the day.
Share prices can change dramatically from one minute to the next and throughout a trading session. Shares can also be bought and sold at a premium or discount their underlying net asset value.
Bond ETFs have no minimum holding time, so there are no penalties for selling soon after making a purchase. They can also be purchased on the margin and sold short, giving them far more trading flexibility than open-ended mutual funds.
Bond ETFs, unlike mutual funds, divulge their underlying holdings daily, providing complete transparency to investors. Bond ETFs provide several advantages over traditional bond mutual funds.
Bond ETFs are tradable to a considerable extent because of their listing on the stock exchange, and they can be quickly sold off without the involvement of the fund house, as in mutual funds.
Mutual fund trading is done only once a day after the market closes. Bond ETFs are highly transparent of their holdings due to regular holdings publishing regulations.
The ETF method reduces paperwork, record-keeping, and distribution costs, among other things. As a result, the overall expense ratio of an ETF is typically lower than a matching mutual fund.
However, not everything is rosy; Bond ETF investors need to shell out commissions to the broker for every trade carried out in the stock market, which can amount to a sizeable sum in the longer run.
The ask spreads can become pretty broad in the bond market, thus eliminating potential returns coupled with the possibility of having the market price of the ETF available at a discount or premium from the NAV, making the ETF proposition less lucrative.
During extreme volatility in the market, bond mutual funds may be worse off as individual bond values are difficult to calculate. Certain bonds can go without trading for several weeks, making such holdings’ value judgment challenging.
On the other hand, ETF prices are kept in check by the power of arbitrage held by the APS. The very organic process of creation and redemption of ETFs makes this a breeze and helps in maintaining the market price of the ETF near the NAV.
Whether to buy a bond fund or a bond ETF is usually based on the investor’s investing goals. Bond mutual funds provide more options if the investor desires active management.
Bond ETFs are a smart alternative if the investor plans to trade regularly. Bond mutual funds and bond ETFs can suit the needs of long-term, buy-and-hold investors, but it’s best to do some homework on the holdings in each fund.
If transparency is vital to the investor, bond ETFs are suitable. If the investor is worried about liquidity and trading volume, a bond fund can be a better option because one can sell the holdings back to the fund provider.
It’s crucial to conduct due diligence and consult with a broker or financial advisor before making any investment decisions.
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