How to emulate a savings account by buying bonds?

Discussion in 'Fixed Income' started by stochastix, Aug 26, 2020.

  1. If I wanted to use the extra cash in my IB account like a savings account.. is that possible, what bond to buy? Do I have to hold it until maturity or can I sell it at any time? I know the basics but could use a little guidance
  2. BMK


    Roughly how much money are you talking about? Corporate bonds have a face value of $1,000 each. But often sellers will only sell in minimum lots of $5,000 or $10,000. Available inventory varies wildly from day to day. The corporate bond market has been turned upside down by the coronavirus. Even before the virus, the corporate bond market was not very liquid. You have the right to sell the bonds at any time, but you may not find a buyer, and if you do, may be selling them for less than you paid for them.

    The interest rates on corporate bonds may look very attractive, e.g., you can buy bonds that are paying rates of 2.5%, 3.5%, 5% or even more. But your actual rate of return is much lower, because you are paying a premium for the bond. You are paying more than the face value, because you are getting an interest rate that is much higher than current rates. So, for example, you might pay $1,102 for a bond that has a face value of $1,000. If you hold it to maturity, you only get $1,000 from the issuer. That extra $102 may be worth paying, because you're getting a nice interest rate from now until maturity. But you have to factor that into your final, total rate of return. You have to subtract the premium ($102 in this example) from all of the interest that you receive from now until maturity.

    There's a little bit more to it than this. You also have to account for accrued interest, which is the interest that has accumulated on the bond since the last interest payment. Interest between payment dates is pro-rated between the buyer and the seller. So when you buy a bond, you have to pay the seller the interest that has accrued up to the date of sale. That amount is included in the total that you pay when you buy the bond.

    Or were you thinking of buying treasuries? All the basic concepts are the same. But treasuries have almost no risk of default, so the interest rates are much, much lower...

    Corporate bonds have real risk. You have to look at the ratings and understand that it is possible that the company could get into trouble, and the rating could be downgraded after you buy the bond. The market value of the bond could tumble, and if you hold on to maturity, and company goes into bankruptcy or receivership, you may not recover all of the principal face value of the bond.

    If you stick with the highest-rated corporate bonds, a downgrade or default is very, very unlikely. But the interest rates on those bonds are very, very low right now.

    You may send me a direct message, and I'll try to answer any questions you may have.

  3. BMK


    Or you can put money in a corporate bond fund, or a corporate bond ETF. But those have a different type of risk.

    Take a look at SPIB. It's a SPDR ETF that holds intermediate term corporate bonds. Pays monthly distributions, currently around six cents per share, which works out be around 2.00% per year. It's very liquid. You can buy and sell shares at any time, with a fairly narrow bid/ask spread.


    Most people think that interest rates are so low right now that they are not likely to go any lower. They will probably only go up. And when they do, the price of the shares in this type of ETF will fall, because the market value of the bonds they are holding will fall, too. And if you then decide you need the money, or you want to use it for something else, you could take a significant hit when you sell the shares.

    If you hold on long enough, the share price will recover. But that could take a long time. And unlike an individual bond, you can't just hold on until maturity and recover the principal value. The shares of the ETF do not have a maturity (LOL).

    You could put money in a fund with a "targeted maturity," and those are a little safer, if you know you can hold on until maturity. With a fund or an ETF, you have sufficient diversification that you don't have to worry about default on individual bonds.

    apdxyk and stochastix like this.
  4. Thank you BMK. I was trying to convince my dad to do something a little more exciting than putting his money in a savings account.
  5. BMK


    Bonds are definitely more exciting than a savings account right now LOL