Why Bonds Are So Important
A fundamental skill to successfully managing wealth is knowing how to diversify our assets. This means we must own both equity and fixed income, with the correct weighting and balance. There isn’t a single solution that fits everyone’s situation. But in general bonds help to protect our wealth against volatility when the stock market goes crazy, which it tends to do once in awhile.
Some kind of mix between safe assets such as bonds, and growth assets such as stocks, has proven to work very well in good economic times and bad. For example, a mix of 80% stocks and 20% bonds in a diversified portfolio would have returned about 8% on average over the past decade, which is not bad since that includes the stock market crash of the 2008 financial crisis.
Financial problems are often cited as the number one reason for divorce. But having some solid bond exposure can bring stability to a relationship. It’s clear that couples are more likely to stay together if they have strong bonds. 😎
The Best Bond Exchange Traded Funds
So what’s the best way to buy bonds? Personally I like to invest in bond ETFs, which hold individual bonds so I stay diversified within this asset class. The following funds are the best Canadian bond ETFs to buy for investors looking at a medium or long term time horizon. I’m no expert but these funds are the best in their categories that I can find. 🙂
- BMO Aggregate Bond Index ETF (ZAG)
A broad index fund that holds both government and corporate bonds. Very diversified. - BMO Mid Corporate Bond ETF (ZCM)
An index fund that holds only corporate bonds with maturities between 5 to 10 years. - iShares Canadian HYBrid Corporate Bond Index ETF (XHB)
Holds lower quality corporate bonds (Mostly BBB rated) with a minimum maturity of 1 year. - Horizons Active Corporate Bond ETF (HAB)
Actively managed corporate bond fund that seeks moderate capital growth and generate high income. - BMO Long Corporate Bond Index ETF (ZLC)
An index fund that holds only corporate bonds with maturities over 10 years.
Here’s a table so you can easily compare all of them. 🙂
| Comparing Bond ETFs | ZAG | ZCM | XHB | HAB | ZLC |
| Price/unit on Jan 2018 | $15 | $16 | $20 | $11 | $18 |
| Gov’t / Corporate % | 72 / 28 | 0 / 100 | 0/ 100 | 0 / 100 | 0 / 100 |
| Net Assets (billions) | $3.4 | $1.4 | $0.5 | $0.6 | $0.4 |
| MER (fees) | 0.14% | 0.34% | 0.51% | 0.60% | 0.34% |
| Weighted Avg duration | 7.5 years | 6.3 years | 5.9 years | 6.2 years | 13.3 years |
| Annual yield | 3.00% | 3.10% | 4.00% | 3.10% | 4.10% |
| Avg YTM | 2.50% | 3.30% | 4.00% | 3.20% | 3.90% |
| % Credit AAA | 41 | 0 | 0 | 2 | 0 |
| % Credit AA | 32 | 13 | 0 | 5 | 1 |
| % Credit A | 17 | 33 | 0 | 38 | 61 |
| % Credit BBB | 10 | 54 | 80 | 51 | 38 |
| % Credit BB or Lower | 0 | 0 | 20 | 0 | 0 |
| 1 year total return | 1.5% | 1.2% | 3.3% | 2.6% | 5.9% |
| 3 year avg return | 1.4% | 2.3% | 3.3% | 2.5% | 3.4% |
| 5 year avg return | 2.7% | 3.6% | 3.9% | 3.2% | 5.1% |
| Additional information | Morningstar: 4
Federal 37% Avg coupon: 3.2 $6,300 to DRIP |
Morningstar: 5
Energy 31% Avg coupon: 3.5 $6,300 to DRIP |
Morningstar: 3
Energy 30% Avg coupon: 4.7 $6,200 to DRIP |
Morningstar: 5
Financial 43% Avg coupon: 4.0 $4,200 to DRIP |
Morningstar: 5
Infrast 43% Avg coupon: 5.4 $5,600 to DRIP |
- The Average duration refers to how sensitive the ETF is to changing interest rates. Longer duration bonds offer higher yields, but are also more sensitive to interest rate movements.
- The weighted average yield to maturity (YTM) includes the interest payments and any capital gain or loss that the investor will realize by holding the bonds to maturity.
- The Credit rating is how risky a bond is. The lower the rating, the more likely the company is to default on its debt obligations.
My personal top pick for 2018 would be the BMO Long Corporate Bond ETF (TSE:ZLC.) Last year ZLC returned about 8% to investors despite a 0.50% interest rate hike by the Central Bank. Out of the five ETFs here I believe ZLC stands the best chance at making the most return not only in 2018, but more importantly in the next 10 years. But this is only based on my personal situation. 🙂 Everyone should do research on their own before risking their hard earned money.
There are dozens of bond ETFs on the market to choose from. Which bond fund do you like?
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Random Useless Fact
I’m really curious why you chose ZLC which has longer duration bonds. Usually when interest rates rise the longer durations don’t do as well. Also curious why you didn’t include short term bond or laddered bonds in your analysis like CBO andCLF?
What percentage of your holdings are in bonds?
Do you hold any prefereds like CPD?
I like longer duration bonds because they pay a higher yield. When rates rise they don’t do well, but when rates fall they do better so I think the bad and good cancel out. As a long term investor my strategy is focused on maximizing the growth of my portfolio for the next 20+ years. Even if interest rates move higher overall funds like ZLC should still produce a higher total return than other types of bond ETF. This isn’t a guarantee, but it’s the kind of trade off and risk I’m willing to make. CBO and CLF are great funds that I would consider if I had a shorter investment time horizon. 🙂 For example, if I receive a large six-figure inheritance, I may put all of it in a short term bond ETF temporarily so I can earn 2% yield with relative safety for up to 1 year, while I think of a longer term strategy. One of my favorite short term bonds is the iShares short term corporate bond (XSH.) It has a low MER and decent yield for what it is. 5 yr average return is 2.22% per year. And it has a 5 star morningstar… Read more »
F35, I have a healthy allocation to different types of bonds through ETFs and funds. VCIT is a good one for US Corporate Bonds. Tom
Thanks for the info. I’m not too familiar with U.S. bonds. I would have to consider the currency risk, but I like Vanguard’s products in general. I’ll have to look into VCIT more. 🙂
-2% total return for me so far on a bond index, but only a small holding and it does smooth out the ride. Balanced allocation is more priority for me
That’s right. I bet your bond fund will do well the next time the stock market doesn’t. 🙂 It’s also harder to hold bonds when interest rates are rising. But it looks like the economy is slowing down so I don’t expect any more rate hikes until this summer at least.
liquid, check out FIG and FSB by First Asset – i think an actively managed solution is where you want to be putting your money in today’s bond market
Thanks Tom. I’ll take a look at those two ETFs.
I have just started shopping for my first bond etf. I have room in my RRSP and TFSA for it. Where do you keep yours? I am not sure how to proceed.
you’d most likely want your highest growth potential asset in your tfsa over rsp, so assuming your other investments are more growth oriented than bonds you’d go bonds in rsp. that being said don’t contribute the funds to your rsp just for that reason.
I keep bonds in both my RRSP and TFSA. The first question I ask is which investment vehicle do I want to max out first. For most people, maxing out their TFSA contribution room is higher priority so any bonds they buy should be held in there. If RRSP contributions are more important based on current and future expected tax liabilities then throw bond ETFs in RRSPs. But some people are fortunate enough to max out both vehicles every year. In that case, it depends on what else they want to invest in. For example, U.S. dividend paying stocks should be held in a $US RRSP account so there is no withholding tax. In order to earmark some RRSP contribution room for U.S. stocks, bond ETFs may be better put into a TFSA. But potentially high growth investments should be put into a TFSA like Ben mentioned. That’s why many people have bought marijuana stocks in their TFSAs. Some have made 10x their money. In a TFSA no capital appreciation is taxed, even if you make 100x your initial investment. But in an RRSP every dollar is taxable whenever the funds are withdrawn. So when we buy $5,500 of high… Read more »
When it comes to asset allocation, do you follow the rule of subtracting 100 to your age equals the percentage that should be invested in bonds? I’m thinking of trying HMMJ than adding more to my bonds since I’m far from retirement age but would love to retire earlier.
I don’t really follow that rule since my financial goals are different than most people. Right now about 7% of my investable assets are in bonds. I don’t think I’ll ever be 50/50 bonds/stocks mix even when I’m in retirement. I’d rather own safe, secure dividend growth stocks, and preferred shares. Bonds are useful as an asset class, but most of them are terrible hedges against inflation which is one of the sure things in centralized economies.
I initially followed the asset rule of bonds=your age but now my bond yield is under 18% (and I’m not 18 haha, it would be nice though if I were younger but also wise). I have Bond ETFs too, but not the ones you mentioned.
Imagine if you had your current wisdom back when you were 18. I would do so many things differently, lol.
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