Individual investment grade bonds owned in a Bond Ladder | Capital preservation - high probability
1) Historically low risk of default.
2) Bond legally required to be paid back at maturity absent default
3) You know dollar principal value at maturity. (Redemption value - what you will receive when redeemed.) Predictable income
1) Known in advance
2) Periodic interest payments typically paid twice per year
3) Interest payment amount known in advance (i.e. before a bond is purchased.) Liquid every business day.
Typically broad market You know what you own at inception
At inception you know the maturity, call dates and interest rate / payments of the bonds you start with. Flexibility
An individual bond can be liquidated at any time at market value to raise cash (If you hold more than the minimum required to be in the ladder) Predictability & low expenses
due to passive management
| Large-(ish) dollar amount needed
Bond ladder typically requires larger dollar amount than sometimes convenient (E.g. $200,000 in a diversified ladder) Market value fluctuates before maturity
(If you need to sell all or part of the bonds before maturity you could receive more or less than "par" or principal at maturity.) Reinvestment Risk
1) New bonds must be bought every time one of your bond matures or is called, to approximately maintain your interest income
2) The future, interest rate and therefore your future interest payments on these new bonds might be smaller. |
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UIT - "Unit Investment Trust" that only owns individual bonds |
Smaller Dollar Amount: Can be owned in typically much smaller dollar amounts than individual bonds in a bond ladder Capital preservation:
as above Predictable income
as above Predictability & low expenses
due to passive management
as above You know what you own
as above Liquidity:
NOT as above. Client can potentially liquidate the entire UIT any business day but not partial liquidations
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Self-liquidating - no flexibility
1) Periodically receive principal as bonds are liquidated.
2) Predetermined. Set by sponsor; not controlled by client Individual client may liquidate remaining UIT any business day at market price
1) But individual client does NOT have the ability to liquidate an individual bond inside the UIT, unlike owning individual bonds in a Bond Ladder
2 Market price fluctuates before maturity
(If you need to sell before it matures.) Reinvestment risk
as above UITs with only investment grade bonds have limited availability
1) Not as numerous or available as individual bonds
2) Might have to decide quickly when they are offered as they can sell out. |
SMA - "Separately Managed Account" that only owns individual bonds
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As Individual bonds in ladder ... Capital preservation - high probability
Historically low risk of default.
Bond legally required to be paid back at maturity absent default
You know dollar principal value at maturity. (Redemption value - what you will receive when redeemed.) Predictable income
Known in advance
Periodic interest payments typically paid twice per year
Interest payment amount known in advance (i.e. before a bond is purchased.) Liquid every business day.
Typically broad market You know what you own at inception
At inception you know the maturity, call dates and interest rate / payments of the bonds you start with. Flexibility
An individual bond can be liquidated at any time at market value to raise cash (If you hold more than the minimum required to be in the ladder) SMA differences Diversification
Potentially greater Active management
To take advantage of mispricing | Large-(ish) dollar amount needed
SMA with individual bonds typically requires larger dollar amount than sometimes convenient (E.g. $200,000 in a diversified ladder) Market value fluctuates before maturity
(If you need to sell all or part of the bonds before maturity you could receive more or less than "par" or principal at maturity. Reinvestment Risk
New bonds must be bought every time one of your bond matures or is called, to approximately maintain your interest income
The future, interest rate and therefore your future interest payments on these new bonds might be smaller. |
Bond Funds | Much smaller dollar amounts required Bonds typically lower volatility than stocks Diversification
1) Potentially much more available
2) Much smaller required dollar amounts mean you can own different bond funds in different categories (e.g. risk level, country, different kinds of issuers - governments, entities, corporations etc.) Lower impact of default risk
1) Because typically many more issuers than ladder or SMA
2) And many more bonds than ladder or SMA.
So impact of potential default of one issuer is smaller Liquid every business day | Capital Preservation potentially less than individual bonds in ladder, UIT or SMA
1) Bonds inside bond fund fluctuate in value
2) Bonds inside bond fund typically not held to maturity
3) So the advantage of a known dollar principal amount to receive at maturity or call simply does not exist for a bond fun Market value typically fluctuates daily Potential loss of principal |
