By Jared Dillian via Iris.xyz
When you invest in bonds, do you buy individual bonds or bond funds?
- Unless you have a lot of money, you should probably buy bond funds.
- And even if you do have a lot of money, you should probably buy bond funds.
Let me explain.
Little Diversification
I have owned individual bonds in the past, for speculative reasons. If you have a brokerage account, they are not that hard to buy.
But individual bonds are not as liquid as stocks. The bid-ask spread (a measure of market liquidity) on a typical bond could be two points wide for a retail client. That is pretty illiquid, so it’s not the type of thing you day-trade.
Short-dated high-grade corporates will be a bit tighter, but it’s not .01 wide like a stock.
If you buy individual bonds, you are probably holding them to maturity. This is especially true in the case of munis, most of which are very illiquid.
I will say that owning individual bonds is fun. It is cool when the semi-annual interest payment hits your account.
But the big problem with owning individual bonds is that it is hard to achieve diversification unless you have a lot of money.
You can achieve diversification with 20-30 stocks. If you own 20-30 bonds, you are still not very well diversified. If one or two of them defaults, your entire returns go down the drain.
This is why people buy bond funds, which have hundreds and hundreds of bonds.
Read the full article at Iris.xyz.
