What’s the Catch?
Owning individual bonds has its risks and rewards. However, buying a bond entails an unseen transaction cost, which may not always be clear to retail investors. This transaction cost exists because bonds are not typically sold with a commission. Instead, a markup is built into the bond price.
This report offers a transparent look at these hidden transaction costs for U.S. municipal and corporate bonds. To determine these costs, we used the investment-grade bonds tracked by the S&P National AMT-Free Municipal Bond Index, the S&P AMT-Free Municipal Series, high-yield bonds tracked by the S&P Municipal Bond High Yield Index, investment-grade corporate bonds tracked by the S&P U.S. Issued Investment Grade Corporate Bond Index, and high-yield corporate bonds tracked by the S&P U.S. Issued High Yield Corporate Bond Index, in conjunction with bond transaction data provided by the Municipal Securities Rulemaking Board (MSRB) and the Financial Industry Regulatory Authority (FINRA). Based on this data, we have determined the average implied transaction cost of municipal bonds since May 2011 and that of corporate bonds since July 2011. This information can help investors compare the cost of buying individual bonds to the cost of investing in bond alternatives, such as mutual funds and exchange-traded funds (ETFs).
Through October 2015, the average implied transaction cost of buying an individual municipal bond of investment-grade quality was 1.21% for retail investors. The average implied transaction cost for high yield municipal bonds was 2.10%. Investment-grade corporate bond transaction costs were lower, at 0.85%, and high-yield corporate bonds had an implied transaction cost of 1.62%.