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Rekenthaler Report

3 Reasons to Own Bonds Directly

And three reasons to choose bond funds instead.


Bond Reason #1: Price
Buying bonds directly costs less than owning actively managed bond funds. Forget the broker’s transaction fee, which, as with stock-trading commissions, has shrunk to almost nothing. The meaningful expenditure comes not from that official charge, but instead from the unstated difference between what the broker paid for the bond and what it charges for its sale. The broker’s profit margin averages about 1% for high-grade corporate bonds.

That amount is roughly double an actively run bond fund’s expense ratio, which runs about 0.50% for the institutional share classes that are currently popular. However, as the bond fund’s expense ratio is levied annually, while the markup on the individual bond is paid only at the time of sale, owning the fund for a decade costs a cumulative 5%, as opposed to 1% for 10-year bonds that are retained until their maturity date.

John Rekenthaler has a position in the following securities mentioned above: PTTRX. Find out about Morningstar’s editorial policies.