(US News) It's all fun and games when the stock market blasts upwards, but with recent volatility and stock market losses, bond investing interest is starting to rise.
The 10-year return for S&P 500 investments that include dividends is 8.42%, that's more than double the return on the 10-year Treasury bond at a measly 3.86%, according to an analysis by Aswath Damodaran, a professor of finance at the Stern School of Business at New York University.
With that, it's easy to discount the importance of bond investing. But investing experts say the diversity of investments is important and using a robo advisor for bond investing can be part of that strategy.
Robo advisors, or digital investment managers, are grounded in smart investing theory and offer bond investing to their clients.
Robo advisors provide limited human intervention.
Investing with robo advisors curtails investors’ worst impulses of excessive trading and overweighting stocks. The lack of human bias and a systematic investment approach wisely allocates bonds along with stocks to robo advisory investment portfolios. But frequently, an equity focus trumps that of fixed investing.
“Because stocks and bonds react differently to adverse market conditions, including both in your portfolio is a great way to reduce your portfolio's sensitivity to market volatility,” says Brian Barnes, founder and CEO of Chicago-based M1 Finance.
Bond ETFs are traded on major exchanges.
These investments are an easy way to diversify and create an income stream, he says.
M1 Finance and many other robo advisors offer bond ETFs for these reasons.
Betterment is the largest standalone robo advisor with $14 billion in assets under management as of August 2018. The firm offers eight classes of bonds that range from U.S. high quality, municipal, inflation-protected, high yield to international bond funds.
“Bonds are added to our portfolios because of their low correlation with stocks, which improves the overall diversification of the portfolio. Another reason bonds are included in investment portfolios is to lower risk. As the risk target for a customer declines, we recommend shorter maturity, higher quality bonds,” says Adam Grealish, director of investing at Betterment in NYC.
The fixed or bond ETFs range in type and number of funds per robo advisor, and it can make a difference in investors’ ultimate returns.
M1 Finance, a free robo advisor and investment manager, offers hundreds of bond-focused ETFs.
Barnes says this gives the investor an opportunity to invest in any type of bond, such as government or corporate, and any credit quality for any duration.
The Betterment robo advisor includes low-cost bond funds that track broadly diversified indexes. “Keeping costs low has been found time and time again to improve investor take-home returns,” Grealish says.
Robo advisors like Betterment include the iShares Core US Aggregate Bond ETF in bond portfolios or a comparable ETF. AGG sports a 5.81 duration and weighted average coupon of 3.38 percent and offers an average yield to maturity of 3.47%.
With a variety of bonds from Treasurys to corporate and a rock-bottom net expense ratio of 0.05%, it’s easy to understand why the fund manages more than $50 billion in assets and is a robo advisor favorite.
Actively managed robo advisor Qplum includes more than 20 fixed income ETFs in its client portfolios. Active management means that Qplum changes investors' portfolios based on market conditions in an attempt to outperform the market returns. Unlike its passively managed competitors, Qplum “uses a broader universe than most other robo advisors because these market conditions are unprecedented," says Mansi Singhal, co-founder of Qplum in New York City.
"Within fixed income, we cover government, corporate, inflation-protected and emerging market bonds. This helps us to express our views within fixed income markets through diversified investments across multiple geographies and durations,” she says.
Fortunately for investors, most robo advisors offer a variety of bond ETFs. Despite robo advisor’s automated algorithm-driven style, investors can change their bond and stock allocations at will with most firms. So more conservative investors can apportion greater percentages to their fixed category and the risk-seeking aggressive investors can minimize bonds and maximize stock allocations.
Whether investors use a robo advisor, financial planner or employ a do-it-yourself investing strategy, it's important to understand how bonds and bond funds behave in a rising-rate environment.
When interest rates increase, so do coupon interest payments. The bonds’ principal value falls due to increasing competition for higher yield new issue bonds.
New bonds added in an ETF will provide higher coupon payments, offsetting the loss of principal from existing bonds.
For that reason, most robo advisors currently tilt their selection of bond ETFs toward short- to medium-term duration bond funds.
Duration refers to a bond’s price sensitivity to changes in interest rates. For example, if a bond has a six-year duration, its price will rise approximately 6% if its yield falls by 1% and vice versa.
Short-term duration bonds temper the negative loss of principal that accompanies rising interest rates.
These bond funds will drop less in value compared with long-term bonds.
Robo advisor investors are assured of diversified investment portfolios with appropriate bond fund allocations. An M1 Finance customer explains the motivation for bond investing, “I invest in bond ETFs because of their low cost and exposure to different pockets of the market.”
Experts say bond ETFs in a portfolio can add stability during market downturns. Robo advisors' bond investments fill the needs of investors seeking cash flow, diversification, volatility reduction, tax protection and international exposure.
