SHOULD YOU BUY INDIVIDUAL BONDS?

Is the best way to invest in bonds to buy individual IOUs or shares in a bond fund?

- PRACTICAL PORTFOLIO BY NELLIE S. HUANG

“We get this question all the time,” says Collin Martin, head of fixed-income strategy and research at the Schwab Center for Financial Research. “And every time, I give the same answer: It depends.”

Mutual and exchange-traded funds certainly make bond investing easy. You pay an annual fee, of course, but the initial investment outlay is low, the fund offers instant diversification, and experts do all the work.

But for investors who seek a specific level of income or who have cash needs at a specific time in the future, a portfolio of individual bonds can make a lot of sense. There are pros and cons to investing in individual bonds, however, and much to consider if you want to invest that way.

The main upside to holding bonds to maturity is that doing so neutralizes interest rate risk. Bond prices and interest rates move inversely—when rates rise, bond prices fall, and vice versa. When the Federal Reserve hiked rates 4.25 percentage points in 2022, for instance, the Bloomberg U.S. Aggregate Bond index sank 13.0%. But when you hold individual bonds to maturity, interest rate fluctuations don’t impact your coupon or principal payouts.

Better yet, when you plan to hold individual bonds to maturity, you know with near certainty, barring a default or an early payoff, exactly when and how much money you’ll get back. That certainty of a payout at maturity is one reason an investor with a looming large expense—a balloon payment on a home equity loan, say, or a tuition bill—might opt to invest in individual bonds. “Few investments give you that kind of predictability,” says Martin.