Advisors should make sure clients understand the difference between bonds and bond funds.
So counsels Marisa Joelson, president of Meta Point Advisors in Vienna, Va., in a column in The Wall Street Journal.
Bond funds have been growing in popularity for an obvious reason: They offer affordable access to a diversified bond portfolio. The problem, however, is clients’ misperception of how they work, Joelson says.
“In particular, clients tend to conflate bond funds with individual bonds,” she says. “It’s a dangerous misunderstanding and one that we as advisers need to do a better job of communicating.”
Barring a default, a bond investor receives principal at maturity, along with regular interest payments. That’s steady, predictable income and downside
Bond funds, while containing bonds, don’t have the same sort of guarantee, Joelson notes. Their value fluctuates in the market.
The advisor notes that the days of 5% bond returns are gone, and it’s hard to find vehicles that offer the same risk/reward fixed-income securities traditionally did.
One solution is setting up a bond ladder with individual bonds as a sort of proxy bond fund.
“Clients still get a portfolio of bonds with staggered maturities, but they have the advantage of the principal protection and predictable income that they forgo in a bond fund or bond ETF,” Joelson says.
This article was originally published in Barron’s.