In times of uncertain global markets and low rates on Treasuries, many investors are turning to bonds for safety. The problem is that fees and other semi-hidden expenses add up fast. Making matters worse, the "relative safety" of bonds may not be all it appears. In this edition of Investing 101, Larry Swedroe of Buckingham Asset Management gives viewers some tips and words for the wise on how to maximize their bond investments.
1. Understand your fees
While not begrudging a broker's right to make a fee on business transactions, Swedroe cautions investors to know exactly what they're being charged. Hint, it may be more than they think.
"The Supreme Court has actually ruled that even fees as much as 6% are not unreasonable," says Swedroe in the attached video. They may not be unreasonable in the eyes of the court, but paying 6% for a bond yielding 3% puts investors in a severe hole. Ask your broker outright about his fees and make sure you're comfortable with them.
2. Use Mutual Funds or ETFs
Rather than going out and buying one bond or another Swedroe suggests using bond ETFs or mutual funds. Available ETFs range from the popular iShares Barclays 20+ Yr Treasury Bond (TLT) for longer term government securities to the SPDR Barclays Capital High Yield ETF with the appropriate ticker (JNK).
Sure, they all have fees as well but "at least with the ETF's you get broad diversification," says Swedroe.
3. Be conservative
Although less risky than stocks in theory, bonds aren't a surefire way to avoid market volatility. With Treasury rates effectively stuck at zero, investors tend to "stretch for yield" as Swedroe puts it. There is no free lunch on Wall Street. If you want returns you have to take risks. In this environment a junk bond may only have a yield of 7% and contain much of the risk of a common stock.
When the risks show up, as they always eventually do, the illusion of safety disappears. These bumps in the road can come as a jolt to conservative bond investors unaccustomed to volatility. Swedroe says this makes bond holders susceptible to giving in to the urge to panic and sell at the lows --an action from which he says you may never be able to recover.