Many investors still do not know where to buy bonds. Many still believe you call up your broker and let him tell you what bonds he has available and the price for each bond. Luckily, for individual investors, the world has changed for the better, making the question of where to buy bonds a no-brainer: buy bonds online.
Where to buy bonds
BondSavvy's focus is recommendations for individual corporate bonds; however, investors can buy corporate bonds, municipal bonds, Treasury bonds, and agency bonds bonds online from a number of online brokers. These bond trading platforms include Fidelity Investments, E*TRADE Financial, Charles Schwab, Interactive Brokers, and Vanguard. Bond investors benefit from many advantages when they buy bonds online, including:1) See the largest amount of corporate bond quotes
2) Minimize corporate bond bid-offer spreads
3) Pay the lowest brokerage commissions
4) Enjoy fast and efficient trade execution
Above all, what buying bonds online does is promote transparency and fairness. Bond investing has come a long way from where it was in the 1980s and 1990s. Today, bond investing is a technology-enabled marketplace where individual investors can typically execute trades at bond prices just as good as the world's largest bond investors, as BondSavvy founder Steve Shaw presented to the SEC.
In the old days, individual investors would call a broker, and the broker would provide a list of corporate bonds and the bond prices at which they were available. There was virtually no way for individual investors to know if they were getting a fair price. Today, individual investors have all the information with the click of a button. They can see how many dealers are providing corporate bond quotes for a particular bond CUSIP and can view TRACE (the Trade Reporting Reporting and Compliance Engine, which is operated by FINRA) data to see historical trades for corporate bonds and how they compare to bond prices offered in the market.
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We discuss details of the advantages of buying bonds online later in this post.
Out of the online brokerage firms, we recommend investors who buy bonds online to have accounts at two brokerages: Fidelity and E*TRADE. Both bond-trading platforms offer a full bond inventory with up to 9,000 individual corporate bonds, quality trade execution, and competitive brokerage commissions.
The primary reason for having accounts at two online brokerages is to ensure you are receiving the best price possible for the bonds you buy and sell. While bond inventory can be similar across online brokerage firms, certain brokerages have different rules with respect to what bond price quotes investors can see. Some brokerages may be more conservative with respect to certain high-yield bonds and may not show all -- or any -- bond price quotes for certain individual corporate bonds. During the peak of the COVID-19 crisis in March 2020, we saw numerous cases where certain online brokerages were showing quotes for a corporate bond and others weren't showing any corporate bond quotes.
Vanguard also offers a good bond-trading platform; however, for accounts less than $500,000, its brokerage commissions are double those of Fidelity and E*TRADE. Vanguard fees are $2 per bond, while Fidelity and E*Trade charge $1 per bond regardless of account size.
Charles Schwab also offers a good bond-trading platform; however, based on our last review of the Schwab bond-trading system, it doesn't show customers the live bid side of a corporate bond quote prior to purchasing the bond. This makes it very difficult to evaluate the level of liquidity available in a corporate bond. In our view, seeing a bond's bid-offer spread is an important part in determining which corporate bonds we recommend to investors purchasing our investment newsletter subscription. We believe, generally speaking, in selling bonds before maturity to maximize investment returns, so knowing the depth of bid quotes on corporate bonds is key to our bond investment analysis.
While BondSavvy is not affiliated with either Fidelity or E*TRADE, our founder Steve Shaw has led investor education webinars for both companies, including:
- August 4, 2020: Steve led a bond investing webinar on Fidelity titled "Corporate Bond Investing in Unprecedented Times," which you can view here
- August 6, 2019: Steve led a bond investing webinar on Fidelity titled "Rethinking Bond Investing," which you can view here
- May 17, 2018: Steve led a bond investing webinar for Fidelity customers titled "The Case for Active Bond Investing"
- November 6, 2018: Steve presented 'Active Corporate Bond Investing' to E*TRADE customers
Investors who know where to buy bonds buy bonds online and benefit from many advantages. It all begins with the number of bond price quotes available at online brokerages, which creates a competitive marketplace with many bonds from which to choose and typically narrow bid-offer spreads.
Please note that bid-offer spreads are the difference between the lowest-priced offer quote and the highest-priced bid quote. These are different than corporate bond credit spreads, which are the difference between a corporate bond's YTM and the YTM of a Treasury bill, note, or bond with a similar maturity date.
We discuss each of the key advantages investors who buy bonds online can enjoy:
See the largest amount of corporate bond price quotes and minimize bid-offer spreads
Online brokerages create a competitive market for your corporate bond investments by aggregating corporate bond quotes from over 100 dealers. These dealers range in size and focus and include Bank of America, Interactive Brokers, Brownstone Investment Group, Sierra Pacific Securities, SumRidge Partners, Wells Fargo, and many more. These dealers are not long-term investors but are rather 'market makers,' who generate profit through buying corporate bonds at the bid price and selling corporate bonds to investors at the offer price.
Typically, for each corporate bond available on an online brokerage, there will be five to twelve dealers providing live-and-executable bid-offer quotes. The below example shows a depth of book for eBay bonds due in 2042 (CUSIP 278642AF0), illustrating how competitive the corporate bond market can be and the narrow corporate bond spreads individual investors can enjoy.
Example of Corporate Bond Price Quotes: eBay 4.00% 7/15/42
* Depth of book shown on Fidelity.com on January 22, 2020.
For the eBay bonds, in this example, 10 dealers were providing live bid quotes and 12 dealers were providing offer quotes. This is a robust level of corporate bond quotes, and not every bond will have this level of liquidity. Generally speaking, bond issues with a greater amount outstanding will often have a larger number of bond price quotes, as these bonds often trade more actively than smaller-sized bond issuances. That said, even corporate bonds that are small in issuance size can trade actively, especially if there is news related to a particular bond issuer.
A 'big issuance' would be a bond that had at least $1 billion outstanding. This eBay bond had $750 million outstanding when the above quotes were available. Bond issuance sizes of $300 million and less can be characterized with fewer available quotes and executed trades. That said, there are many corporate bonds with small issuance sizes that trade actively and can have as many live bond price quotes as shown above.
Examples of such bonds include two Bed Bath bonds, one maturing in 2024 (CUSIP 075896AA8) and other Bed Bath bonds maturing in 2034 (CUSIP 075896AB6). Both Bed Bath bonds are only $300 million in original issuance size but can, at times, trade more than 100 times in one trading day.
If a bond trades more actively, bond investors have a greater number of data points to determine they are getting a good price for a bond, as they can view TRACE-reported trades in their brokerage account and compare the live bond price quotes to recently executed corporate bond trades. This is a far cry from the way the corporate bond market worked decades ago, as corporate bonds today trade in a competitive marketplace with typically reasonably narrow bid-offer spreads.
In the eBay bonds shown above, the bonds were quoted with a bid-offer spread of 0.12 points, on a dollar-price basis, and 0.01 percentage points (or 1 basis point) on a yield-to-maturity basis. Corporate bond bid-offer spreads can vary based on the maturity of the bond, how actively the bond trades, and the number of dealers providing bond price quotes.
Bonds with a long time to maturity, such as the eBay '42 bonds, will often have wider bid-offer spreads on a dollar-price basis. The reason for this is bonds with a longer time to maturity are more sensitive to changes in interest rates since changes in interest rates will impact the bondholder for a longer period of time than they do for investors in shorter-term bonds.
For corporate bonds, interest rate risk is largest for long-dated investment-grade corporate bonds, where prices can be heavily impacted by changes in underlying Treasury yields. Movements in corporate bond credit spreads can either amplify or mitigate the impact of falling or rising US Treasury yields.
It's important for investors to weigh interest rate risk and credit risk when evaluating new corporate bond investments.
Please note the eBay bonds information was taken before Covid-19 set in and represents what bond quotes look like in 'normal' times. For many corporate bonds, Covid-19 created historic bond price volatility that reduced the number of live quotes. Subsequent to the depths of the Covid-19 crisis in March 2020, the corporate bond market returned to a more normal situation, with the typical level of live corporate bond quotes. It is important, however, for investors to understand that, during extreme times such as the Covid-19 crisis, bond market liquidity can dry up quickly, and it can be difficult to buy and sell bonds at compelling prices.
During parts of March and April 2020, there were often no live corporate bond quotes on the bid side. During this time, BondSavvy moved its recommendations to "hold" until corporate bond markets began to recover. Over time, we began moving recommendations back to 'buy' as bond market conditions improved and we evaluated how the issuers of our recommended bonds would weather the Covid-19 crisis.
Do all brokerages show customers competitive quotes?
Most online brokerages differ from traditional brokerages, as traditional brokerages, such as Merrill Lynch and Morgan Stanley, often do not enable customers to see all of the bond price quotes provided by third-party dealers (aka "Street Inventory"). They, instead, often only show customers corporate bonds their trading desks are quoting. As a result, these customers often see less bond inventory at worse prices since they do not enjoy the benefit of competitive bond price quotes.
Pay the lowest bond trading fees
If a Fidelity customer was to purchase the above eBay bonds at a price of 100.094, Fidelity would mark up the eBay bonds by 0.1 points, which is equivalent to $1 per $1,000 face value of bonds. Since bonds are quoted as a percentage of their face value, a bond price quote of 100.094 means the value of the bond is $1,000.94. With the $1 mark-up, the customer would pay $1,001.94 for each of the eBay bonds plus accrued interest from the last coupon payment date.
These bond brokerage commissions are in sharp contrast to bond trading fees charged by traditional brokerages, which often charge a two-point markup for each bond. For example, that same bond quoted at 100.094 would be often be shown to a customer of a traditional brokerage at 102.094 -- a two-point markup. This bond brokerage commission is equivalent to $20 per bond, or 20x the amount charged on Fidelity.com and other online brokerages. These fees add up, as an investor would pay $2,000 to purchase a $100,000 face value bond portfolio and then another $2,000 if the investor elected to sell bonds before maturity. Depending on how long an investor owns a particular bond, these brokerage commissions could exceed bond fund management fees for a similarly sized portfolio. Minimizing transaction and management fees is a key advantage investors receive when they buy bonds online.
Read our fixed income blog post to learn how an investor would have saved approximately $48,000 in financial advisor commissions if he were to buy bonds online rather than through a traditional brokerage.
Enjoy fast and efficient bond trade execution
BondSavvy founder Steve Shaw is the former head of Tradeweb direct and a senior executive of BondDesk Group, two companies that built the technology for retail brokerages to buy and sell bonds online on behalf of their investor clients. He saw firsthand the level of investment made to ensure fast and efficient bond trade execution. Today, nearly all bond trades with a live quote are filled promptly, with order submission to trade execution often taking less than one second. Technology companies such as Tradeweb and ICE BondPoint and retail brokerages have invested heavily to make bond investing more fair and efficient for individual investors. We expect this investment and focus to continue and for individual investors to be the beneficiary of improvements made to US corporate bond market trading.