Stocks and bonds stand as pillars in the investment landscape, each offering distinct advantages. While stocks signify ownership in a company, bonds denote debt and are among the oldest investment forms.
As investors seek diversification, understanding the contrast between individual bonds and innovative Bond exchange-traded funds (ETFs) is crucial.
In this blog let’s understand the key differences between Individual bonds and bond ETFs.
Understanding Bonds
Bonds serve as secured instruments, authorized by entities to raise funds for specific purposes. They can be issued by the government, or corporations. These have a fixed duration, during which investors receive regular interest payments. Once the bond term concludes, the invested amount is returned to the investors. Examples include SGB (Sovereign Gold Bonds), RBI Bonds, G-Sec (Government Security Bonds), Zero Coupon Bonds, and Corporate Bonds.
Understanding Bond ETFs
Bond ETFs are an alternate approach to investing in bonds, structured as ETFs to leverage their advantages. They represent a collection of bonds grouped to form an exchange-traded fund (ETF). Similar to other ETFs, bond ETFs follow an underlying index composed of bonds. These ETFs monitor the performance of such indexes. Despite being solely composed of bonds, they can be traded on the stock exchange, just like any other ETF.
Some notable examples of Bond ETFs in India include Bharat Bond ETF and Nippon ETF Long Term Gilt.
Difference between Bonds and Bonds ETFs
The following are some key distinctions between bonds and bond ETFs:
| Aspect | Bonds | Bond ETFs |
| Nature | Individual debt instruments with set maturity and returns | A basket of bonds traded as a single investment, offering diversified exposure |
| Investment Cost | Purchased individually, potentially incurring higher costs | Acquired as a bundled investment, often with lower costs compared to individual bonds |
| Diversification | Offers exposure to a single bond per investment | Provides diversified exposure to multiple bonds, enhancing portfolio diversification |
| Maturity | Has specific maturity dates with principal repayment | Lacks fixed maturity dates, value tied to underlying bonds’ performance |
| Payouts | Bonds offer fixed returns at predetermined intervals | Bond ETFs may comprise bonds with varying interest payout schedules, often resolving this by providing agreed-upon payouts monthly |
Conclusion
Traditionally, cautious investors like bonds, but they come with drawbacks like limited returns and low liquidity. Investing in Bond ETFs helps overcome these issues and offers extra advantages like diversification and perpetual maturity. For retail investors, buying multiple bonds can be expensive, but ETFs offer a simpler solution.
FAQs
- What role do credit ratings play in individual bonds?
Credit ratings assess the creditworthiness of bond issuers, helping investors gauge default risks associated with bonds.
- Are government bonds considered safer than corporate bonds in India?
Government bonds are generally perceived as safer due to lower default risk, backed by the government’s credit, compared to corporate bonds.
- How can investors analyze and choose between individual bonds and bond ETFs?
Investors should consider factors like their investment goals, risk tolerance, time horizon, and understanding of market dynamics before choosing between individual bonds and bond ETFs.
- Are bond ETFs less risky than individual bonds?
Bond ETFs may spread risk across various bonds, potentially reducing specific issuer risk, but they still carry market risks and are subject to price fluctuations.
- Are bond ETFs popular in India?
Bond ETFs are gaining popularity in India due to their diversification benefits and ease of trading on stock exchanges.