Would you ever buy a car—or even a new pair of shoes—without looking for the best deal? Probably not. So, why don't more investors comparison shop for bonds?
"Many investors simply don't realize different firms charge different prices for the exact same bond," says Kathy Jones, managing director and chief fixed income strategist at the Schwab Center for Financial Research.
The problem stems from the fact that bonds don't trade on centralized markets like stocks, which makes their true cost difficult—if not impossible—to ascertain. Instead, most are purchased "over the counter" through a brokerage firm that buys the bond on your behalf. The firm then tacks on a fee, or markup, that can range from a fraction of a percent to several percentage points, depending on factors such as bond liquidity and the firm executing the trade.
"Too many brokerages not only charge far too much but also conceal such costs from investors," Kathy says. So, before you buy your next bond, ask your broker these important questions—and be sure you're satisfied with the answers.
- What's the market price? This will reflect the actual price it costs your broker to buy a bond from another dealer (which may include fees paid to the dealer).
- What's the markup? A markup refers to the difference between the market price of a bond and the price a broker-dealer charges to sell it. A markup is generally wrapped into the price—and may or may not be disclosed.
- Are there additional fees? In addition to markup, brokers may charge miscellaneous fees to cover administrative services, clearing fees, overhead, etc.—which, as with the markup, they may or may not be required to disclose.
- What's the accrued interest? When you buy a bond between coupon payment dates, you'll owe the seller any accrued interest since the last payment date. This cost has nothing to do with your broker but does factor into the total cost.
- What's the overall cost? This will include all of the above: the market price plus any markup, additional fees, and accrued interest.
"Be wary of firms that fail to give you direct answers about their fees," Kathy advises. "They're probably being opaque for a reason."
Indeed, even seemingly small differences in markups can mean giving up hundreds, if not thousands, of dollars in total returns over time. And with prices and yields fluctuating to the degree they have recently, it pays to shop around.
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Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk.
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