Direct investments in individual corporate bonds can achieve a higher return on investment than bond mutual funds and bond ETFs. Investors can also better assess the risk of investing in individual bonds since they know a bond's maturity date, coupon, and credit risk prior to buying the bond. This investment information is not easily available for most bond mutual funds since they own thousands of bonds and frequently turn over their investments, resulting in high trading costs that are undisclosed and reduce investment returns.
|Corporate Bonds||Bond Funds|
|Higher potential after-tax returns|
|Easier to buy & sell|
|No recurring fees|
|Pays fixed coupon|
|Returns principal at maturity|
When investors own individual corporate bonds, they pay a transaction fee to buy and a
transaction fee to sell. On platforms
such as Fidelity.com and E*TRADE, this fee is $1 per bond. Therefore, if you own a
portfolio of 100 bonds and sell
it after three years, your total fees paid would have been $200. This represents
significant savings to bond funds,
many of which charge 1% management fees. Had an investor opted to put $100,000
into a bond fund charging 1% during
this three-year period, he would have paid $3,000 in fees (+/- depending on investment
returns) compared to the $200 paid
by the individual corporate bond investor.
Had this investor subscribed to BondSavvy, his total fees paid, including the $200 transaction fees, would have been a fraction of what a 1% management fee fund investor would pay. In addition, there are hidden bond fund fees embedded in bond funds and ETFs that are not disclosed to investors. These trading-related fees are due to the high turnover of many bond funds, understate a bond fund investor's true cost of investing, and markedly reduce bond fund investment returns.
The entire premise of fixed income investing is that you receive a fixed coupon payment twice per year and the return of your principal at maturity. It’s why they call it “fixed income.” Investors receive this when they invest in individual bonds. They don’t receive either in bond funds, which is why we say “bond funds take the 'fixed' out of fixed income."
In the world of mutual funds, it’s an alphabet soup of investor classes and fees, which
typically translates into smaller investors
paying a higher percentage of their investment in fees than larger investors, which is a
regressive tax in our book. For
example, the BlackRock High Yield Bond Portfolio has an A, B, B1, C, C1, K, R and an
Institutional Class. Those in the
lowly C Class paid 1.64% of their investment in fees during the year ended September 30,
2018 while those in the Institutional
Class only paid 0.61%. In addition, B Class holders are subject to a sales fee when they
Apart from these stated fees, the fund has significant hidden trading fees, as the BlackRock High Yield Bond Portfolio had turnover of 90% for the twelve months ending September 30, 2018. These hidden bond fund fees hurt bond fund returns and are a key reason why a select portfolio of individual bonds can outperform the leading bond funds.
It’s a very different story when investing in individual corporate bonds, as someone investing $5,000 can pay the same price for a bond as someone investing $250,000. In addition, with bid-offer spreads typically between one-quarter to a full point, investors electing to sell bonds before maturity can do so without the excessive fees and transaction costs of many fixed income mutual funds.