Bond ETFs vs actual bonds

Question

If the goal is to diversify a portfolio and add bond investments in a manner like that described in Intelligent Investor, would owning a bond ETF provide the required diversity or does it need to be actual bonds?

My concern is that in the event of the stock market tanking, a bond ETF might also face liquidity problems and possible loss of value, where as, if you own several actual bonds - then you can hold them to maturity (and provided the company can still pay it back) you'd get your money back.

It seems an ETF allows you to invest in a large range of bonds for a low fee, to invest a small amount into 10+ actual bonds has a high commission cost. So then you lose diversity because all your bond-eggs are in a small basket.

Are bond ETF's considered compatible with direct bond investment for the purposes of diversifying?

Answer 1

ETFs are just like any other mutual fund; they hold a mix of assets described by their prospectus. If that mix fits your needs for diversification and the costs of buying/selling/holding are low, it's as worth considering as a traditional fund with the same mix.

A bond fund will hold a mixture of bonds. Whether that mix is sufficiently diversified for you, or whether you want a different fund or a mix of funds, is a judgement call.

I want my money to take care of itself for the most part, so most of the bond portion is in a low-fee Total Bond Market Index fund (which tries to match the performance of bonds in general). That could as easily be an ETF, but happens not to be.

Answer 2

As keshlam said, an ETF holds various assets, but the level of diversification depends on the individual ETF. A bond ETF can focus on short term bonds, long term bonds, domestic bonds, foreign bonds, government bonds, corporate bonds, low risk, high risk, or a mixture of any of those.

Vanguard Total International Bond ETF (BNDX) for instance tries to be geographically diverse.