Target Maturity Bond Funds: Alternative to Laddering
One of the decisions fixed-income investors have always faced is the choice between investing in individual bonds or bond funds.
Bond funds provide extensive diversification in a single investment, but they also don’t have a maturity date, which means that investors have no guarantee that all of their principal will be there at a specific point in the future, as is the case with individual bonds.
Investors can also create a “ladder”—or a series of bonds with different maturity dates—out of five or more individual bonds. This option enables the investor to manage interest rate risk and ensure predictable cash flows, and it helps mitigates the risk of principal loss associated with bond funds. However, this approach also results in a lower degree of portfolio diversification.
Bridging the Gap
Now, investors can address all of these needs by investing in target maturity bond exchange-traded funds, or ETFs. These funds behave like regular ETFs, except all of the bonds mature in the same year. As each bond matures, the funds move the proceeds into cash or cash equivalents rather than reinvesting them. At the funds’ maturity dates, they cease operations and their value at the time is returned to shareholders. In this way, investors can earn income, own a liquid (easily traded) investment, and have a known date at which their principal will be returned (a plus for those who are investing with a specific goal in mind, such as college payments). In addition, they can help investors build bond ladders and still maintain a high level of diversification.
Target maturity funds aren’t without their risks. They don’t seek to return a predetermined amount of cash to investors at the maturity date, so the principal that gets returned may be less than the original investment if one or more of the bonds in the portfolios default (this risk can be mitigated by investing in target maturity funds investing only in the highest rated bonds). Also, these funds will fluctuate—just as any fund would—so buying and selling throughout the life of the fund carries the risk of loss. The further away from the maturity date, the more volatile the fund. As a result, investors who need an absolute guarantee that all of their principal will be returned should look elsewhere, accepting at the same time that short-term bond funds, targeted or otherwise, may hold investments with lower scheduled interest rates.
A closer look at how these funds work can be found via iShares' case study of its 2013 S&P AMT-Free Municipal Bond Series ETF (MUAA), which has now matured. See the study here.
The yields on target-date maturity funds will fluctuate, but generally speaking, the longer maturity funds will carry higher yields. Check the websites of the issuing companies to find out the funds’ current yields.
The expense ratios for the funds are 0.30% for the iShares series, 0.24% for the Guggenheim corporate bond series, and 0.42% for the Guggenheim high yield series. Note as well that several studies confirm that in the past funds with higher management fees have lower returns.
How to Invest
ETFs can be purchased by setting up a brokerage account. The list of target maturity bond ETFs is as follows:
- iShares 2017 S&P AMT-Free Municipal Bond Series ETF (MUAF)
- iShares 2018 S&P AMT-Free Municipal Bond Series ETF (MUAG)
- iShares 2019 S&P AMT-Free Municipal Bond Series ETF (MUAH)
- Guggenheim BulletShares 2017 Corporate Bond ETF (BSCH)
- Guggenheim BulletShares 2018 Corporate Bond ETF (BSCI)
- Guggenheim BulletShares 2019 Corporate Bond ETF (BSCJ)
- Guggenheim BulletShares 2020 Corporate Bond ETF (BSCK)
- Guggenheim BulletShares 2021 Corporate Bond ETF (BSCL)
- Guggenheim BulletShares 2022 Corporate Bond ETF (BSCM)
- iShares 2016 Investment Grade Corporate ex-Financials Term ETF (IBCB)
- iShares 2018 Investment Grade Corporate ex-Financials Term ETF (IBCC)
- iShares 2020 Investment Grade Corporate ex-Financials Term ETF (IBCD)
- iShares 2023 Investment Grade Corporate ex-Financials Term ETF (IBCE)
- iSharesBond 2016 Corporate Term ETF (IBDA)
- iSharesBond 2018 Corporate Term ETF (IBDB)
- iSharesBond 2020 Corporate Term ETF (IBDC)
- iSharesBond 2023 Corporate Term ETF (IBDD)
High Yield Bonds
- Guggenheim BulletShares 2017 High Yield Corporate Bond ETF (BSJH)
- Guggenheim BulletShares 2018 High Yield Corporate Bond ETF (BSJI)
- Guggenheim BulletShares 2019 High Yield Corporate Bond ETF (BSJJ)
- Guggenheim BulletShares 2020 High Yield Corporate Bond ETF (BSJK)
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.