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Why I like my Bond ETFs

Maybe it’s because the market is up and down all over the place and I’m thinking about them more.

Maybe it’s because bonds are one of the first things I learned about when I opened my RRSP account almost 12 years ago.

Maybe it’s because they saved my hide, like my friend “Bond, James Bond” does with his girl in the movies.  Bonds saved my behind when the TSX plummeted to the mid-7000’s and equities were on fire (as in, burning down to you know where) in 2008-2009.

I like my bond ETFs.

Here are some of my favourite reasons why I like my bond ETFs, why and where I own them, in particular my Canadian bond ETFs.

  •  Government bonds, are pretty much risk-free; the government can raise taxes or create additional currency in order to redeem the bond at maturity and cover its IOU.  Sure, there are some examples where a government has defaulted on its debt (Russia, 1998) but this is rare.  Don’t worry folks, I don’t think the U.S. is going to default on its debt – the U.S. just has a heckuva lot of debt to pay back and needs to get going on it!  Here is nifty little gadget that shows how fast the U.S. debt is growing.  Look at the top left of all the calculators you see to find “US National Debt”.  Kinda cool, then again, kinda scary.   Alas, we are talking about Canadian government debt – almost as risk-free as it gets.
  • Government bonds have a similar yield to big bank GICs.  Personally, I’m a fan of CLF, CBO, XBB and XSB, which are all exchange traded funds (ETFs).   You can find CLF and CBO at Claymore’s site and XBB and XSB at iShares site.  I’ll have a post in the coming weeks to explain why these bond ETFs in particular are my favourites, but for this post and this bullet point, you should know you get a dependable yield from any of these ETFs.  I do.  XBB, for example, is yielding about 2.5% if all the coupons that XBB holds are held to maturity.  Last month, for my account in particular, I got paid $0.09 for every share owned of XBB.  After accumulating a bunch of XBB shares over the years, I’m now getting enough income from XBB distributions every month to buy one more XBB share – commission free.  That’s right, just like John Heinzl’s dividend-paying stocks (and my own for that matter), now my bond compounding machine is running full steam ahead.  Click here to learn more about XBB, its holding, distributions and more.
  • Government bonds, particularly bond ETFs like all the ones I mentioned above are very easy to buy.   I can buy my CLF which is my favourite Claymore bond ETF (or any other bond ETF) directly through my discount brokerage account.  I do have to be careful though, I don’t want to be buying bonds all the time since it costs me transaction fees.  Fees and the impacts they have on your portfolio are forever.   Also, and more importantly, I don’t want to be buying bonds when markets are falling.  That just wouldn’t make sense.  You buy stocks and bonds when they are low(er) in price – right? :)
  • My bond ETFs are very transparent.  I know exactly what each bond ETF holds.  Don’t believe me?  Click any of the links above to CLF or XBB.  They have nothing to hide.
  • Taxes can get a bit tricky if you buy bonds individually.  That’s why, I don’t even bother with individual bonds.  I use bond ETFs instead (which have low management fees by the way) and I put them in my RRSP.  This way, I don’t have to worry about the tax-math in a non-registered account.  I suppose you could put your bond ETFs in your TFSA.  The coupons (meaning interest) is provided tax-free and the shares can compound over time, like I wrote above.  Furthermore, I don’t have to worry about a capital gain or a loss.
  • I like dull and boring investments.   Bonds have a deserved reputation for this, which is fine by me because frankly, I’d rather have some security in my portfolio than fret about what Mr. Market is doing any given day.  It really doesn’t matter to me with my bond ETFs.   Like my friend Dividend Ninja recently said on his blog:  “One thing I do know for sure is I have a nice income generating and balanced portfolio which is priceless when stock prices go down. I could have easily gone with a 100% dividend portfolio in 2009, but I didn’t, I saw how bonds gave me a cushion and income through the decade.”  Ninja – I couldn’t have written this better myself.

I think 98% of investors should have bonds in their portfolio.  Canadian Couch Potato thinks it’s a good idea, my friend who is a Millionaire Teacher in Sinapore owns them, another friend who is a Wealthy Canadian who invests mainly with dividend-paying stocks is considering some for his portfolio and countless other bloggers listed on my Blogroll who are very savvy DIY investors own them.  The other 2%?  Well, those investors are either VERY diversified via stocks (I’m talking 50+ here at least) or they have plenty of income from other means to simply not need the capital protection and fixed income that bonds offer.  I’m definitely not in that camp and I’m betting you’re not either if you’re reading this blog.

The closing message here is blunt:  bonds should be part of almost anyone’s portfolio.  They’re a part of mine and they’re not going anywhere soon.  They help me sleep through anything Mr. Market serves up.

Give them some notice and respect, just like James Bond.

What about you?  Do you own bond ETFs in your portfolio?  What do you own and why do you own them?

Filed in: Bonds, Index Investing

23 Responses to "Why I like my Bond ETFs"

  1. I agree that most people should have some bonds if for no other reason than to increase the odds that they won’t panic and sell off everything at a bad time. I’m curious, though, why you think that none of your readers have high income. Are you just going with the odds that any particular reader likely has modest income or do you really think that none of your readers have high income? Maybe I should ask as well what you consider to be high income.

    • @Michael,

      I’m playing the odds here, my readers have likely modest-moderate incomes. This is not to say some readers of blogs, p/f, investing sites (including this one) do not have high incomes at all, rather, when I speak of high incomes or portfolios, I’m talking seven-figures. I would think most folks learning, reading and contributing to personal finance and investing discussions are not uber-wealthy. I’m certainly not. I could be proven wrong though. What’s your take?

  2. MOA, great post and reminder my friend! Thanx for the mention also ;)

    When stocks are doing well, especially after a year long run-up, people seem adverse to the suggestion of hoding bonds. Even with record low interest rates they are still the safe haven when markets tank (especially short-term bonds). People forget why one would invest in bonds in the first place – to protect your portfolio against market declines, and give you a cushion with income during those times. I think after this little market dip, since this wasn’t the big one, a few people may be reconsidering.

    Andrew Hallam really has the right idea when he talks about bonds as his secret weapon, selling them high when markets tank to buy much undervalued equities, and vica versa (htough he does that within his asset allocation). I know a 100% dividend stock portfolio works for some, but I honestly don’t have the stomach for it. When this market decline hit I knew I had the bonds to back me up, and I slept well at night thank you :)

    The bond ETFs you describe are all excellent choices for Canadian Investors. For those with small investment portfolios consider the TD Canadian Bond Index – e series fund, with an MER (Management Expense Ratio) of 0.49%. I usually park my short-term funds here. Although it holds long-duration bonds as well, it’s done quite nicely in the current market decline.

    Cheers
    The Dividend Ninja

    • @Ninja,

      Thanks for your detailed contribution!

      I like your thinking, even with record low interest rates, bonds are a good place to be; at least some bonds! Your comment about “a cushion” is an excellent one and a great metaphor.

      When doesn’t Andrew Hallam make sense? :)

      I don’t have the stomach for all “all in equity” portfolio as well. I’m just not that risky.

      I like the choice you’ve made with the parking your short-term funds. I will need to consider that as well.

  3. First off, great job finding that pic! My favorite Bond movie is Casino Royale by a long shot :)

    It’s no coincidence that your were thinking about your bond positions given the volatility in the markets we have been witnessing over the past several days. During times like these, thoughts of ‘safety’ seem to hit home rather quickly.

    I do fall under the 2% category, but I can assure you that even though I have over 60 stocks in my portfolio, I place a heavy importance in fixed income – just not bonds (yet). In fact, I have 20%+ of my net worth tucked away in fixed income & guaranteed interest accounts. This amount was actually about 43% prior to investing in a few rental properties.

    Like you, over the past few days, it’s definitely been a comforting feeling knowing that I have a safety net, and knowing that I’m adding farmland to my portfolio as an extra recessionary resistant play, makes things even more comforting, mentally.

    It’s ironic how so many of us criticize safety plays because of the low yields, yet when the headwinds come, and we know it’s inevitable that they will, we realize just how important it is to have safety in one’s overall portfolio.

    Like Ninja said, having a cushion is of paramount importance during times of volatility.

    With that being said, I am a firm believer in having a well-rounded diversified portfolio, and that includes tangible assets. Paper wealth can dissipate but the four walls of a home or property can’t.

    Even though I don’t own any bonds as of now, I have a certain figure that I first want to reach on the guaranteed interest term side of things. After that point, I will likely be adding to my safety positions in the form of bond ETFs. Like you, I don’t think I’ll ever buy bonds directly, only in the form of an ETF. Guess which site I’ll visit when that time comes? :)

    The only real difficulty I have with bonds is the lack of clarity (or maybe its the lack of understanding on my part) in terms of what we are to expect distribution wise.

    Taking XBB as an example, I notice that this ETF currently indicates a ‘yield’ of about 3.6% and pays a monthly distribution. But when I look at the distribution history, it appears as though the income you receive can fluctuate widely from year to year, is that correct? It’s almost as if there exists a sort of deceptiveness. From what I can gather, it’s the ETF’s yield to maturity that is really the true indicator for expected distribution, correct? If so, than XBB appears to offer the investor closer to 2.56%. If I’m not mistaken, we still have to deduct the MER of 0.32%, leaving a net ‘yield’ if you will, of 2.24%.

    If memory serves me correct, this is one of the reasons why I initially focused on GIAs/GICs/guaranteed interest terms within my fixed income/guaranteed investment vehicles. My roots are a strictly income-oriented investor, so it’s hard for me to crack out of my shell so to speak by not analyzing to death what the true cash flow will be.

    At any rate, I’m surely going to want to own bond ETFs at one point for my overall portfolio. I guess I’ll just wait for solid bull rally :)

    Great post; thanks also for the mention!

    • @TWC,

      No problem with the mention.

      Yes, I guess it was natural to think about bonds as you say, those markets can one emotional – but emotions are evil when it comes to investing.

      Over 60 stocks is pretty great TWC. Really, I wish I was there with you. Ah, someday. Glad to hear you place some importance in fixed income. I think some fixed income simply makes sense.

      You said it well: you can criticize the safety play all you want, but “when the headwinds come, and we know it’s inevitable that they will, we realize just how important it is to have safety in one’s overall portfolio.”

      Taking XBB as an example, yield to maturity is 2.56%, this is the important one, although distribution is 3.6%. The distribution yield fluctuates since it depends upon the maturing holdings in the bond. It’s really not overly deceptive but one could be confused by taking the distribution yield as the true bond yield, which is not correct. I wrote a post about that, after I was fortunate enough to chat with Som Seif, CEO of Claymore. You can check out the post on my blog, here:

      http://www.myownadvisor.ca/2011/06/28/understanding-yield-to-maturity-is-important/

      The yield to maturity of a bond ETF isn’t exact, because the proceeds from maturing bonds are frequently rolled over into new bonds, while the ETF itself never matures. Bond yields are very low now, but they won’t always be. Regardless, they give me “a cushion” as Ninja says in times of turbulence. You are correct that yield to maturity is shown without an adjustment for MER; which is an industry standard.

      On the flipside TWC, now that I have a nice soft pillow in my RRSP with bonds, I can pretty much be on the full-time hunt for great dividend-payings stocks. That’s not so dull and boring :)

      Thanks for your really in-depth comment!

  4. @MOA

    Thanks a lot for the clarification; the post you did back in June is a superb one. Combined with a link to Don Bortolloti’s article, I now feel acquainted enough with bond ETFs.

    Given recent news, it doesn’t seem as though interest rates will be on the rise anytime soon.

    Looking at the long-term chart of CLF, I can now fully appreciate Andrew Hallam’s strategy in terms of timing his offloading of bonds and entry into stocks (or indexes) when there’s a lot of volatility in the markets.

    Good stuff.

  5. Amit says:

    I own 16% of my portfolio in following Bond ETFs:
    XRB, XSB in Canada (1% each of overall portfolio)
    BIV, BND, IEF, JNK, HYG from USA (2% each)
    FXA representing developed nation (2%) -> using currency ETF as a bond etf
    PCY, FXM representing the emerging markets (1% each)

    They have indeed provided a good cushion to me during the falling market as well as provide steady monthly income. The rest of the 84% of my portfolio is in dividend growth stocks.

    • @Amit,

      Nice, it appears you like bonds ETFs as well! With XSB, you’re short bonds, and with XRB, you’re long bonds so at least with the former should interest rates ever and I mean ever rise again, then you’re set with XSB.

      I’m not too familar with those U.S. ETFs, but have heard of HYG which is a riskier corporate high-yield bond.

      I too, have a few dividend-payers in my portfolio and I only hope to add more over time. Thanks for your comment!

  6. pursuit says:

    Thanks for the very helpful information. I wonder if you could do an article on your thoughts on high-yield (ie junk bond) etfs.

  7. I agree that bonds are close to essential in most portfolios. I just finished up my series on portfolio construction, and this last part was mainly on bonds.

    I prefer the Vanguard Total Bond Market as my primary bond holding. Lately I’ve been liking corporate bonds, though.

    Treasury Inflation Protected Securities might not be a bad choice for US investors. There’s an ETF for that. They can protect a portion of the bond portfolio from inflation.

    Love the Bond pic, too.

    • @Dividend Monk,

      Yes, I liked your post, in fact, the entire series. It was really well done.

      I don’t own much corporate debt yet, although I might own CBO at some point in my RRSP.

      Anything that protects investors against inflation is probably a good holding. Inflation is a portfolio killer. That’s why I don’t keep lots of cash on hand. I’d rather be invested.

      Thanks for your comment, stay in touch!

  8. My threshold of high incomes is lower than 7 figures, but 7 figures sounds about right as a large portfolio. My experience with people who make, say, above $200k is that they are usually smart but little better at investing than less affluent people.

  9. You are a very smart individual!

  10. Hank Scorpio says:

    Great commentary for those that are primarily GIC type investors, however you don’t make much of a compelling argument.

    Sure it’s easy to love bonds when interest rates are falling – what about when they start to rise? This is going to put a hurting on the Bond ETF’s share prices.

    As a income investor what is it about a bond ETF that you find preferable over a Preferred Stock ETF, or owning actual bonds or convertible debentures themselves?

    I’m not saying the article is right or wrong – rather it would have been more beneficial if you could have compared and contrasted an income producing bond ETF portfolio – paying 4.5% to a nominally higher risk Preferred or Dividend ETF portfolio paying 7%.

    • @Hank,

      Thanks for your comment!

      Yes, I know bond prices are going to hurt eventually, but I will still hold them. I strongly believe in bonds as part of my portfolio and I don’t intend on selling any of them long-term. They provide me with a nice pillow to sleep at night.

      I own bond ETFs because I don’t see any dividend ETF as a substitute for bonds. Sure, dividend-paying stocks are nice, preferred ETFs are nice as well, but they are no substitute. Some government debt is always good debt to own, that is my personal investing rule of thumb. I will eventually hold some corporate debt as well. It’s all about being very diversified long-term to withstand any financial storm.

      You disagree? Thoughts? I’d like to hear more about your take on preferred or dividend ETFs – it’s always good for me to understand another point of view.

  11. Bernice Bessellieu says:

    Bookmarked – will come back within in a few days to evaluate rest articles.

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