Background: I am constructing a simple ETF portfolio consisting of 70% stocks and 30% bonds. Every three months, I will add money into the portfolio, and rebalance the portfolio to restore its 70/30 allocation. I am aiming for something similar to the Bogleheads' two-fund portfolio, with 70% invested in a global stock ETF and 30% invested in bonds.
Suppose I have access to the following instruments to fill the bond component of the portfolio:
- An investment grade bond ETF.
- A special risk-free savings bond with slightly higher yield than the bond ETF above (for the same duration as the bond ETF). Assume that this bond is truly risk-free, and has a low minimum investment requirement.
My question is about the bond ETF vs the individual bond. From my understanding, there are advantages of having a bond ETF in a portfolio:
- The periodic 70%/30% rebalancing automatically ensures that stocks tend to be sold when stock prices goes up, and bought when stock prices go down.
- The bond component reduces the volatility of the portfolio, because bonds are typically less volatile than stocks.
- As a result, most of the stock market returns are captured with less volatility.
Do these advantages also apply to the individual bond? Due to the risk-free nature of the individual bond and its higher yield, I am considering investing the entire bond component in the individual bond instead of the bond ETF. Besides the liquidity of ETFs, are there reasons for choosing the bond ETF over the risk-free bond in question?
In other words, do bond funds have an inherent advantage over individual bonds within a periodically rebalanced portfolio that has a fixed bond allocation?
What I would really like to know is: Do bond funds have an inherent advantage over individual bonds such that I should overlook the lower risk and higher yield of the individual bond in question, and instead invest my money in a bond ETF?