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While similar to other ETFs, bond ETFs are unique in the world of fixed income because, as they are traded on stock exchanges, the current and historical prices of bond ETFs are available to all investors. Historically, this kind of price transparency for bonds has been available only to institutional investors. Bond ETFs are available on a global basis.
There are two reasons to consider investing in a bond ETF. The first is to provide a relatively steady stream of income. If you're older, you may appreciate the stability that comes from income generating investments. The other reason is to decrease overall portfolio volatility because bonds and stocks often don't move in concert with each other. However, be careful to not overweight your bond holdings if you're young as you run the risk of decreasing portfolio returns.
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. (However, the tax efficiency of bond ETFs is not a big factor because capital gains do not play as big of a part in bond returns as they do in stock returns.)
Note that bond funds differ from bonds in that they have no par value. As such a bond fund can lose value and never recapture it.
One disadvantage of bond ETFs is that they charge an ongoing management fee. While lower spreads on trading bond ETFs help offset this somewhat, the issue will still prevail with a buy-and-hold strategy over the longer term. The initial trading spread advantage of bond ETFs is eroded over time by the annual management fee.
Another disadvantage is that there is no flexibility to create something unique for a portfolio.
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