Baby Bonds: Your Guide to Exchange Traded Debt Securities.
Many beginner investors want to start with low-risk investments.
But how do you do it?
The common answer is to start investing in bonds. This is sound advice, but not the most exciting one. Safety and low risk can often come at the expense of excitement and opportunities for big gains.
But there is an option that promises safety within the market itself: Exchange Traded Debt Securities, a.k.a. ETDs or baby bonds.
These unique securities are designed to appeal to new investors who want to develop a solid base for their portfolios that consists of more than just bonds.
It should be noted that this article will be discussing “baby bonds” relative to ETDs, as in those that have an at par value of under $1000. These are the most commonly discussed form of these securities.
The return is consistent, and ETDs are set to become the next big thing for beginning investors.
What are ETDs?
The strictest definition of a baby bond comes from Investopedia: “Fixed income securities issued in small denominations, generally with a maximum face value of $5,000.”
These securities can be affiliated with a government or business development companies, and it is important to know which is behind your ETD when investing.
A business development company is designed specifically to issue loans to midmarket companies. They fund businesses with a lower risk in the chain of investment than venture capital.
It is in their best interest to provide a steady and safe supply of capital for the investors receiving and contributing to the company.
Yes and no.
What’s the history of ETDs?
ETDs, as we know them today, are mostly tied to companies.
ETDs affiliated with governments have a long history in the United States. Franklin Delano Roosevelt was filmed purchasing six ETDs in 1935, promoting the use of the small bonds.
The use of the term “baby bond” may have emerged from the bond’s use as a future investment for one’s children, taking into account the themes of security. This is marketing not unlike that of the modern Gerber Grow-Up Plan.
Are ETDs good for retirement investment?
Depending on type and turnover, baby bonds may provide reliable passive income or serve as bonus income during retirement.
For example: With strategic investment, an ETD investment paying 8% plus $1500 per month in social security income would net you $42,000 a year in retirement income.
Liquidity is not often a concern for ETDs, so this may free up resources for other investments in the portfolio.
ETDs can be sold at any time after purchase, allowing for more flexibility within portfolio building.
A “survivor’s option” exists for some ETDs, enabling cashing out by beneficiaries. This may appeal to retirees looking to invest in stock options with easily accessible options to their heir.
How do ETDs compare to preferred stock?
ETDs are safer than even preferred stock and subordinate only to secured debt. They may even be more secure than municipal debt under some circumstances.
ETDs may be particularly attractive to those who prefer the security of preferred stock but prefer a higher liquidity.
Are ETDs really purchasable for as low as $25?
They are also taxable at income tax level. This stems from the fact that the income they provide is set as interest and not dividends. However, this means that investors will not be eligible for decreased tax rates based on their investments.
A highly attractive aspect to ETDs is the appeal of no minimum purchase requirement. Check your individual investment to ensure that this is the case for you.
ETDs are an acceptable alternative to penny stocks for those seeking to begin investing at a low price rate.
This is also a way to begin investing in the debt market without heavy investment in an individual company.
They are also considered senior to equity, which may lead to them actually being considered debt under the company’s own classification.
Are ETDs secure for general investing?
ETDs are considered extremely secure.
However, ETDs are still valid on the NYSE (click the link for a list) and Nasdaq. They can still be influenced by company movement and experience volatility.
It is best to plan around the terms and conditions of the individual ETD. Not all perform best over time and should not be considered as stable as an actual bond.
They do not rank as stable as investments associated with banking institutions or secured debt.
What’s the return on ETDs?
The return for an ETD depends entirely on the issuer of the ETD. There is no standard rate due to issuers potentially belonging to private companies or government entities.
ETDs frequently have returns of 8%.
However, this is not a consistent result, and new investors should not expect to make this amount with every purchased ETD.
That’s not to say that consistent 8% return is impossible for ETDs.
I own two baby bonds. The first is Travel Centers of America 8.25% Senior Notes (TANNI) and Qwest Corporation 7.5% notes (CTW).
The Travel Centers of America baby bonds pay quarterly interest – on the 15th of January, April, July, and October. And the Qwest baby bonds pay on the 15th of March, June, September, and December. I hold these in my IRA so the income is shielded and I bought them at a discount below their $25 face value!
Where do ETDs fit in into my investment plan?
An ETD is a great option for a passive income producing, secure investment to round out a portfolio. They may counterbalance more risky investments such as those purchased in an IPO.
If there is insecurity around government bonds, ETD investment may serve the same purpose regarding stability.
ETDs can provide diversification even if the investor prefers low-risk investments.
What are the risks of investing in ETDs?
ETDs are designed to be secure for the issuer and purchaser. But ETDs are callable before maturity, and you may be subject to a return earlier than you may expect.
Older models of ETDs had shorter maturity times (about 10 years). Read the terms carefully before investing and know your rights as the investor.
An attractive aspect to ETDs is the long maturity time, often 30 years or longer.
However, certain ETDs may have times as short as 5 years. This must be accounted for and researched by new investors.
Quarterly payments are typical for ETDs but may vary by type and issuer. Liquidity is also not consistent and should be researched before investment.
Interest payments for ETDs may be deferred, but this is not a universal rule. Check the terms of the individual investment to know your options with your investment.
What are the safest ETDs to invest in?
There is no universally recognized “best” ETD.
ETD can be evaluated according to their reliability or their potential yield. Read evaluations and decide according to your individual needs.
Every ETD is tied to an individual company, and their performance is tied to the ability of the company’s ability to pay their debt. It is imperative that you research the company whose debt of which the ETD is comprised.
If the debt is unreliable or the company has a bad repayment record, reconsider the investment.
Declaration of bankruptcy by the original company tied to the debt may threaten your investment. You may also be at risk if refinancing occurs.
In the event of a corporate takeover, your ETD investment may not convert to stock or other holdings.
Credit rating is also not consistent across all ETDs.
Take time to learn the types of exchange-traded products and their associated risks before investing.
Are longer maturity times better for ETDs?
This is highly dependent on the nature of the individual ETD.
Select an ETD with an equal balance between steady growth and the possibility for early redemption.
ETDs are not designed for pump and dump maneuvering, but an agile investor should take advantage of their ability to provide worth before the callable period.
Short maturity lengths also do not indicate a weak ETD.
Research the companies associated with individual companies before purchase. This will give a better indicator of potential future performance than similar ETDs.
ETDs are considered stable investments overall.They are a great alternative to bonds for investors looking to expand their portfolio in a low-risk fashion.
When investing in an ETD, take care to read the terms of investing before purchasing. Terms (including interest) may vary between types.
Take care to observe and research the conditions under which your ETD may be callable before maturity.
ETDs will likely continue to expand in popularity as a choice for new investors. They contain many of the advantages of a typical stock option but retain many secure aspects of common bonds.