We’re hearing from many advisors that they’re turning to term-maturity bond ETFs instead of building traditional bond ladders with individual bonds. Below are the key reasons why—and how both approaches compare across important factors.
1. Diversification and Credit Exposure
Term-Maturity Bond ETFs
Pros
Broad exposure: These funds hold many bonds that mature in the same year, spreading out issuer risk.
Automatic updates: As bonds mature, the fund reinvests to keep aligned with the target year.
Cons
Less flexibility: The fund follows an index, limiting choices around credit quality or sectors.
Sampling risk: Some funds don’t hold all bonds in the index, which may cause small tracking differences.
Individual Bonds
Pros
Full control: Advisors choose specific issuers, ratings, sectors, and bond features.
Custom maturity ladder: Bonds can be structured to match exact cash-flow needs.
Cons
Concentrated risk: Fewer holdings mean more exposure to any one bond.
Manual oversight: Credit monitoring and reinvestment are hands-on responsibilities.
2. Liquidity and Trading Costs
Term-Maturity Bond ETFs
Pros
Easy trading: ETFs trade on exchanges with generally tight bid-ask spreads.
No bond-by-bond fees: Investors pay only the ETF’s expense ratio, not commissions.
Cons
Premium/discount risk: ETFs can trade slightly above or below their net value.
Redemption pressure: Large investor outflows near maturity may lower pricing.
Individual Bonds
Pros
Direct execution: Advisors control purchase and sale timing.
Cons
Limited liquidity: Some bonds are harder to trade and have wider spreads.
Transaction costs: Dealers may charge up to 1% of the bond’s value.
3. Yield, Fees, and Return
Term-Maturity Bond ETFs
Pros
Blended income: The yield reflects an average across the fund’s holdings, after fees.
Transparent costs: Expense ratios are consistent and clearly disclosed.
Cons
Lower net returns: Management fees reduce overall gains over time.
Reinvestment varies: Interest is paid out, and how it’s reinvested depends on the platform.
Individual Bonds
Pros
Known yield: Buying at par locks in the return to maturity (assuming no default).
No fund fees: Investors keep full coupon payments.
Cons
Reinvestment required: Coupons and maturities need manual reinvestment, which may occur at lower rates.
Price complexity: Buying above or below par adds extra tax and accounting steps.
4. Taxes and Reporting
Term-Maturity Bond ETFs
Pros
Simplified reporting: Investors typically receive a single 1099-INT and 1099-B.
Cons
Taxable distributions: Gains from bond sales in the ETF may be passed on to shareholders.
Individual Bonds
Pros
Deferral control: Taxes on gains are due only when bonds are sold.
IRS rules: Premium or discount amounts can be amortized over time.
Cons
More paperwork: Each bond sale creates a separate tax event.
Added complexity: Premium/discount handling can be intricate.
Final Thought for Advisors
Term-maturity ETFs are a good fit for advisors seeking a simple, low-maintenance way to manage fixed-income exposure with a clear end date and transparent costs.
For those who want full control over bond features and timing—and are prepared to manage the moving parts—individual bonds offer flexibility and precision.
In practice, many advisors are combining both: using term-maturity ETFs as a core and layering in individual bonds to adjust for yield, cash flow, or credit preferences. This can strike the right balance between efficiency and customization.