What Are Fixed Income ETFs and How They Compare to Other Investments

Fixed income ETFs are a type of investment that allows you to diversify your portfolio by investing in a basket of bonds, which can provide a regular income stream.

They are often compared to individual bonds, which can be less liquid and more expensive to buy and sell.

Fixed income ETFs can be a more cost-effective option, with some fees as low as 0.04% per year, as mentioned in the article section "How Much Do Fixed Income ETFs Cost".

One of the key benefits of fixed income ETFs is their ability to provide a regular income stream, which can be attractive to investors who are looking for a steady source of returns.

Fixed income ETFs are a type of investment that exclusively focuses on bonds. They hold a portfolio of bonds with different strategies and holding periods, similar to bond mutual funds.

These funds are passively managed and trade on major stock exchanges, promoting market stability by adding liquidity and transparency during times of stress.

Fixed income ETFs offer a range of investment options to suit different needs and goals. You can choose from various types of fixed income ETFs, including those that invest in Treasury bonds, corporate bonds, and international bonds.

Treasury bond ETFs, such as SCHO and PLW, invest in government securities, which are generally considered low-risk investments. Corporate bond ETFs, like AGG and LKOR, invest in bonds issued by companies, which can offer higher yields but also come with a higher risk of default.

Some fixed income ETFs are designed to provide a broader exposure to the bond market. Total bond-market ETFs, for example, invest in the entire U.S. bond market, making them a good option for investors who are unsure of what type to invest in.

Here are some examples of fixed income ETFs across different categories:

Rate volatility has a way of shaking things up in the fixed income world. In the past year, investors have flocked to money market funds as a safe haven, with $1.2 trillion in inflows that pushed their aggregate net assets to a record $6.4 trillion.

Investors are drawn to money market funds because they offer a relatively safe and reliable option, especially with the Federal Reserve holding rates steady. But as the Fed begins cutting interest rates, the direction of money market fund inflows is likely to reverse.

Short-term bond ETFs are another option that can help investors navigate rate volatility. These ETFs hold short-term bonds that mature in less than a few years, making them less sensitive to interest rate changes and therefore lower risk.

Active core bond ETFs and a mix of short and intermediate investment-grade bond ETFs are also likely to see inflows from investors seeking reliable income with greater stability.

Investment Grade Bond ETFs are a great option for those looking for a more stable and secure investment.

Investment Grade Bond ETFs primarily invest in higher-quality securities, which generally include those issued by the U.S. Treasury, U.S. government agencies, and U.S. corporations.

These bonds are considered to be of lower risk and offer relatively lower returns compared to other types of bonds.

Fidelity offers a range of Investment Grade Bond ETFs, including the Fidelity Investment Grade Bond ETF (FIGB) and the Fidelity Investment Grade Securitized ETF (FSEC).

Investors can also consider the Fidelity Sustainable Core Plus Bond ETF (FSBD) and the Fidelity Total Bond ETF (FBND) for a more diversified investment portfolio.

Here are some examples of Fidelity's Investment Grade Bond ETFs:

Investment Grade Bond ETFs can be a good starting point for investors who are new to fixed income investing or who want to add a stable investment to their portfolio.

High Yield bond ETFs are a type of fixed income investment that focuses on lower-quality securities. These funds typically invest in bonds rated BB and below, which carry a higher level of credit risk.

The Fidelity High Yield Factor ETF (FDHY) and Fidelity Sustainable High Yield ETF (FSYD) are examples of High Yield bond ETFs.

Preferred securities are a type of hybrid investment that combines the features and characteristics of both stocks and bonds. They offer a unique combination of regular income and relatively low risk.

Preferred securities are issued by companies to raise capital, and they typically have a higher claim on assets than common stockholders. This means that in the event of bankruptcy, preferred shareholders are paid back before common shareholders.

Preferred securities can be thought of as a cross between a bond and a stock. They offer a fixed rate of return, like a bond, but they also participate in the company's growth, like a stock.

Municipal bonds are a type of fixed income investment that can offer tax benefits. You'll avoid federal taxes on municipal bond ETFs, but you'll only escape state taxes if the ETF invests exclusively in a state where you pay taxes.

These ETFs hold securities issued by states and cities, which are typically tax-advantaged bonds.

Intermediate-term bond ETFs typically hold bonds that mature between a few years and 10 years or so. This allows them to pay more than short-term bond ETFs.

These ETFs can move quite a bit in response to changes in the interest rate, making them a bit riskier than shorter-term options.

Investing in fixed income ETFs can be a great way to earn regular income and diversify your portfolio.

To get started, you'll need to choose a brokerage account that offers low fees and a wide selection of fixed income ETFs.

Fixed income ETFs can be broadly categorized into two types: government-backed and corporate-backed.

Government-backed fixed income ETFs invest in government securities, which are considered to be very low-risk.

Some popular examples of government-backed fixed income ETFs include the iShares 1-3 Year Credit Bond ETF and the Vanguard Short-Term Bond ETF.

Corporate-backed fixed income ETFs, on the other hand, invest in corporate bonds, which carry slightly more risk but also offer higher returns.

Before investing in fixed income ETFs, it's essential to understand the fees associated with the fund.

The fees for fixed income ETFs can vary widely, ranging from 0.05% to 1.00% per year.

A good rule of thumb is to look for funds with low fees, as they can eat into your returns over time.

It's also crucial to consider the credit quality of the bonds held within the ETF.

The credit quality of the bonds held within the ETF can significantly impact the fund's overall risk and return profile.

For example, the iShares 1-3 Year Credit Bond ETF has a high credit quality rating, which means it invests in bonds with a lower risk of default.

Ultimately, the key to successful investing in fixed income ETFs is to have a long-term perspective and a solid understanding of the underlying bonds.

Fixed income ETFs offer many benefits, including the chance to receive regular coupon payments, which can happen every month, unlike traditional bonds that pay interest every six months.

One of the most significant advantages of owning bond ETFs is the diversified bond holdings across a range of bond types, from U.S. Treasuries to junk bonds.

However, bond ETFs also come with some risks, such as the lack of liquidity in the bond market, which makes it difficult to ensure a bond ETF encompasses enough liquid bonds to track an index.

Investors' initial investments are at greater risk in an ETF than an individual bond, as there's no guarantee the principal will be repaid in full since a bond ETF never matures.

Bond ETFs offer a convenient way to diversify your portfolio by buying just one or two securities. They can provide a lot of value for investors.

In 2022, the asset-weighted average expense ratio for an index bond ETF was 0.11 percent, or about $11 per $10,000 invested. This is a significant decrease from 0.26 percent in 2010.

To minimize the downsides of bond ETFs, search for funds with lower expense ratios. This will put more of your fund's yield into your own pocket instead of the fund company's.

Bond ETFs may have relatively high expense ratios, which can eat up a sizable portion of the interest generated by the holdings. A bond fund's expenses may turn a small yield into a miniscule one.

Here are some potential downsides to consider:

No guarantees of principal mean that if interest rates turn against you, the wrong kind of bond fund may decline a lot. If you have to sell when the bond ETF is down, no one will pay you back for the decline.

Bond ETFs offer many benefits, including a regular coupon payment, which is typically paid every six months. This can provide a predictable source of income for investors.

One of the most significant advantages of bond ETFs is that they hold assets with different maturity dates, allowing for a constantly changing portfolio that doesn't mature. This makes it difficult for the architect of a bond ETF to ensure it closely tracks its respective index in a cost-effective manner.

The expense ratio for bond ETFs has been moving in the right direction, with the asset-weighted average expense ratio for an index bond ETF being 0.11 percent in 2022, down from 0.26 percent in 2010. This means that investors can keep more of their fund's yield in their own pocket.

However, there are some limitations to bond ETFs, including the fact that an investor's initial investment is at greater risk than with an individual bond. Since a bond ETF never matures, there isn't a guarantee the principal will be repaid in full.

Interest rates can also harm the price of a bond ETF, making it difficult to mitigate interest rate risk. This is because the ETF does not mature, unlike an individual bond.

Bond ETFs pay dividends on a monthly basis based on the interest income earned on the bonds held in the fund's portfolio. This means you can expect to receive a regular income stream from your bond ETF investments.

Some bond ETFs may offer a higher dividend yield compared to others, depending on the specific bonds they hold in their portfolio. This can be a significant advantage for income-seeking investors.

Bond ETFs typically distribute dividends in the form of cash, which is then credited to your brokerage account. You can then choose to reinvest the dividends or withdraw the cash as needed.

Fixed income ETFs offer a relatively low-risk investment option with a potential for regular income through dividend payments.

They tend to be less volatile than stocks, which can be appealing to investors seeking stability.

In comparison to bonds, fixed income ETFs provide diversification benefits by investing in a pool of bonds, reducing the risk associated with individual bond holdings.

However, fixed income ETFs often come with higher fees than individual bonds or other investment options, which can eat into returns.

Some fixed income ETFs, like those that track government or corporate bond indexes, can be more liquid than individual bonds, making it easier to buy and sell shares.

This liquidity can be beneficial for investors who need to access their money quickly.

In terms of tax efficiency, fixed income ETFs can be a good option for tax-conscious investors, as they often pass through interest income to shareholders, allowing them to claim the interest as income on their tax returns.

Fixed income ETFs offer a wide range of debt securities, combining the benefits of bonds with the flexibility, transparency, and liquidity of the ETF wrapper.

They provide significantly more liquidity than the underlying bonds, thanks to two layers of liquidity: primary market creation and redemption, and secondary market trading on exchanges.

This superior liquidity facilitates trading in otherwise highly illiquid bond markets, setting ETFs apart from individual bond portfolios and mutual funds.

Bond ETFs are available for a variety of bond categories, including Treasuries, corporates, convertibles, and floating-rate bonds.

Some examples of bond ETFs include:

Bond ETFs can be traded like shares of stock on exchanges, allowing investors to buy and sell them easily.

Understanding Fixed Income ETFs starts with recognizing the key differences between traditional bonds and bond ETFs. Bond ETFs trade on a centralized exchange, unlike individual bonds which are sold over the counter by bond brokers.

One of the main benefits of bond ETFs is their liquidity, which is significantly higher than individual bonds and mutual funds. This is because bond ETFs have two layers of liquidity: primary market creation and redemption, and secondary market trading on exchanges.

Bond ETFs are available on a global basis, offering investors exposure to a wide range of debt securities. They can be used to gain passive exposure to benchmark bond indices at an inexpensive cost.

Bond ETFs pay out interest through a monthly dividend, while any capital gains are paid out through an annual dividend. For tax purposes, these dividends are treated as either income or capital gains.

The tax efficiency of bond ETFs is not a significant factor, as capital gains do not play a big role in bond returns. In fact, bond ETFs are often used as a low-risk investment option for investors seeking reliable income with greater stability.

Here are some key characteristics of bond ETFs:

These characteristics make bond ETFs an attractive option for investors seeking to diversify their portfolios and manage risk.

ICE's fair value methodology helps reduce index tracking error by using a combination of market data and rules-based procedures to estimate the fair value of bonds in the index.

This approach is particularly useful for fixed income ETFs, which aim to track a specific index, such as the ICE BofA US High Yield Index.

By using fair value estimates, ICE's methodology can help minimize the impact of illiquidity and other market factors that can cause index tracking error.

ICE's fair value estimates are based on a variety of market data sources, including broker-dealer quotes, trade data, and other market information.

The use of fair value estimates can also help to reduce the impact of outliers and other anomalies in the market data that can cause tracking error.

The ICE BofA US High Yield Index, for example, uses a combination of market data and rules-based procedures to estimate the fair value of high-yield bonds in the index.

This approach has helped to reduce the index tracking error of fixed income ETFs that track the ICE BofA US High Yield Index.