Risk-Averse Investors: Don't Overlook This Simple Wealth-Building Tool
Key Points
Bond ETFs work by pooling your money with that of others to invest in hundreds of different bonds.
With the diversification provided by a bond ETF, your level of risk is automatically spread out.
Before investing, make sure to understand an ETF's top holdings and the risks relative to them.
As an investor, you know that reward is often preceded by risk. However, if you tend to be averse to risk, you may wonder if your path to wealth is destined to be an uphill battle. While some investments are more secure than others, the truth is that all investments carry some degree of risk. The trick is finding a level you can live with.
You do have options, including bond ETFs. Let's see how they could help your portfolio.
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Strategic protection of your money
When you invest in any exchange-traded fund (ETF), your money is pooled with that of other investors to buy and sell stocks, bonds, and other commodities on stock exchanges. The beauty of bond ETFs -- particularly for a risk-averse investor -- is that they provide exposure to a wide range of bond types, which reduces your overall risk. When one type of bond takes a beating, you have others to help keep your portfolio afloat.
Like all ETFs, bond ETFs typically protect your hard-earned money by carrying lower expense ratios and being more tax-efficient than mutual funds. In addition, because bond ETFs invest in interest-paying securities, most offer a steady, predictable income.
When you're ready to buy
As you study bond ETF options, pay special attention to the types of bonds the ETF tilts toward. That knowledge will give you a sense of how much risk you're taking by investing, mainly because each type of bond carries its own level of risk. For example, here are three popular bond options:
- U.S. Treasuries: Considered a low-risk investment because the federal government backs them. However, U.S. Treasuries generally offer lower returns.
- Corporate bonds: Tend to offer higher yields but carry greater risk.
- Mortgage-backed securities (MBS): As the name suggests, these bonds are backed by mortgage loans. MBS tend to offer a middle ground with varying levels of risk and return.
While bond ETFS can be a great addition to a diversified portfolio, no ETF is entirely risk-free. Here are three reasons why:
- Interest rates: As interest rates rise, bond prices fall.
- Risk of default: There's a risk that a bond issuer will fail to make interest payments or repay the principal.
- Market fluctuations: All ETFs are subject to market fluctuations that can affect their value.
Although they're not without risks, bond ETFs can be a solid choice if you're seeking broad exposure to the U.S. bond market. While bonds are one of the less sexy investment vehicles on the market, they tend to remain stable over time. If you're willing to buy and hold through the ups and downs, a bond ETF can provide you with the added touch of security you crave.
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