Bond mutual funds, bond ETFs, and preferred securities

Whether your goal is to diversify your portfolio, help to protect against stock market volatility, or generate current income, these investments offer convenient fixed income solutions.

Bond mutual funds

  • Bond mutual funds

    A bond mutual fund is an investment vehicle that pools money from investors and "mutually" buys various types of bond investments. Bond mutual funds offer a convenient way to own a professionally managed, diversified bond portfolio. If you're looking for oversight of the securities held, the option to automatically reinvest interest payments, while tolerating some fluctuations in monthly income and the investment value, then consider bond mutual funds.

Benefits and Risks

Bond Mutual Funds benefits and risks
Benefits Risks
Professional management – Bond funds are run by professional portfolio managers who specialize in certain bond sectors or strategies who may leverage extensive research and market information to keep the fund aligned with its stated objectives.

Diversification – By investing in bonds and other debt securities, you may be able to help lower the overall risk of your portfolio. 

Liquidity – Because they can be bought and sold at the closing net asset value (NAV) each day, bond mutual funds tend to be liquid. 

Low investment minimums – Bond mutual funds can have minimums as low as $1.

Automatic investing – Schwab's Automatic Investment Plan allows investors to automatically invest a fixed-dollar amount on a regular basis in one or more mutual funds. 

Reinvestment of dividends and capital gains – Investors who don't need the income have the option to automatically reinvest interest and capital gains back in the fund.  
Trading limitations – Bond mutual funds only trade once a day, after the market closes. Because you can't transact intraday, you won't know the exact price at which you will buy or sell a mutual fund when you place your order. 

Limited transparency – Mutual funds generally only disclose their portfolio holdings quarterly. 

Lack of customization – Bond funds are managed according to the stated objectives in the prospectus and cannot be customized. 

Potential less tax efficiency – Bond funds may not be tax-efficient since they usually distribute capital gains to investors. They provided limited opportunity for implementing tax-saving strategies, such as tax-loss harvesting. 

Lack of control – The bond fund manager determines the timing of buys and sells and securities for a fund. At times, the manager may be forced to sell positions in the fund to meet liquidations.

Bond ETFs

  • Bond ETFs

    When you buy shares of a bond ETF, you buy a piece of a bond portfolio. However, unlike individual bonds, most bond ETFs don't have a maturity date. And ETFs trade on an exchange, like stocks, so you can buy or sell them at any time during the trading day.

Benefits and Risks

Bond ETFs benefits and risks
Benefits Risks
Diversification – Because they generally invest in many individual bonds from different issuers, bond ETFs can help mitigate the impact to the investor if the bonds from a single issuer either fall in value or default. 

Tax efficiency – ETFs often generate fewer capital gains for investors since they may have lower turnover and can use the in-kind creation/redemption process to manage the cost basis of their holdings. 

Transparency – Holdings are generally disclosed daily, so investors know exactly what securities their ETFs hold. 

Flexibility – Like stocks, bond ETFs trade throughout the day and can use limit and stop-limit orders. 

Expenses – Bond ETFs typically have lower operating expense ratios (OERs) than bond mutual funds, especially actively managed funds. 
Price to net asset value – The market price of a bond ETF could vary from the net asset value (NAV) of the underlying securities. While the share value is usually close to the NAV, in some cases the price may be more or less than the underlying value per share. 

General liquidity – An ETF's liquidity is based on the number of market makers (firms that stand ready to buy or sell throughout the trading day) interested in buying or selling that ETF at given point in time. Higher liquidity can shrink bid/ask spreads, since the more interested market makers there are, the closer the highest and lowest offered prices to sell are likely to be. Similarly, ETFs with lower liquidity tend to have larger bid/ask spreads.

Preferred Securities

  • Preferred securities

    Preferred securities are hybrid investments that share characteristics of both stocks and bonds. They can offer higher yields than many traditional fixed income investments, but they come with different risks.

Benefits and Risks

Preferred Securities benefits and risks
Benefits Risks
Regular income – Preferred securities usually pay quarterly dividend or interest payments. 

Senior to common stocks – Preferred securities are senior to common stock in payment of interest or dividends, so they are paid out before payments are made to common stockholders. 

Liquidity – Most preferred securities are quoted and traded on a stock exchange, so their price is visible at all times and they can be tracked and traded throughout the day. 

Trading flexibility – Stop orders can be used on exchange-traded preferred securities to manage risk.

Credit rating – Because preferred securities are lower in the capital structure than bonds, the credit rating for preferred securities is generally lower than that for the bonds the company issues. 

Interest rate fluctuation – Due to their long maturity dates (or lack of a maturity date in some cases), the prices of preferred securities are generally very sensitive to changes in interest rates. 

No dividend guarantees – For many preferred securities, a missed coupon payment doesn't necessarily constitute a default. Unpaid coupon payments accrue to holders of cumulative preferred securities, but they are lost with non-cumulative preferred securities. 

Call risk – Call risk is the risk that the security gets redeemed by the issuer prior to maturity. Securities are usually called when interest rates fall, meaning investors will likely be reinvesting in a lower interest rate. 

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