The truth about bond prices

Retail buyers usually pay a big premium—1% or more—over the wholesale or institutional market.

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From the December/January 2014 issue of the magazine.

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Q: I have 95% of my bond investments in an ETF with a low yield. Instead of investing such a large amount in a bond fund, should I search for individual bonds offering higher returns?

—Jim Semple, Regina

A: You’ve probably seen those obnoxious ads offering “factory direct” pricing. They promise great savings on furniture or flooring by cutting out the middleman. Unfortunately you can’t go direct to the factory when it comes to bonds. “Individual investors are at a disadvantage in buying bonds because unlike stocks, bonds trade from dealers’ inventories,” says Terry Shaunessy, president of Shaunessy Investment Counsel. “Pricing is not transparent. Retail buyers usually pay a big premium—1% or more—over the wholesale or institutional market.” If you want to increase your yield, you could go with a corporate bond ETF or allocate some of your fixed-income portfolio to a preferred-share ETF. Both options involve a bit more risk, but offer the prospect of extra reward.

Ask Moneysense About EFTs

One comment on “The truth about bond prices

  1. The “1% premium on individual bonds” argument for buying a bond fund or ETF is no longer valid.

    Many discount brokers (Qtrade, iTrade, HSBC Direct, etc.) no longer trade bonds from their own inventories, but rather they now use an Alternative Trading System (ATS), like Perimeter’s CBID Market ( http://www.pfin.ca/index.php ). This ATS platform eliminates the hidden, imbedded, commissions inherent in the old school “Over-The-Counter” (OTC) system.

    Even for those investors still using a broker with an OTC platform, buying a individual bond, maturing in 5 years, paying a 1%premium still makes sense (that 1% premium averages out to 0.20% per year).

    It’s still a lot cheaper to buy individual bonds than it is to buy and hold an ETF or mutual fund that charges 0.50% to 1.50% each year. (Over 5-years, those ETFs and mutual funds cost you between 2.50% and 7.50%)

    Understanding investment costs and the math behind them is important.

    http://www.investingforme.com/classroom/investment-costs

    Reply

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