## Monday, November 17, 2008

Whenever I buy bonds through my discount broker, the commissions they charge me are hidden. When I want to buy a particular bond, they just quote me a price, and when I decide to sell the bond, they just quote me another price. There is never any mention of commissions.

Of course, discount brokers don’t let you trade bonds out of the goodness of their hearts; they make money somewhere. With stocks it is more obvious. You pay commissions and lose some money on the spread between bid and ask prices.

Right now I only have one bond. It is a British Columbia coupon for \$14,000 coming due 2010 June 18. A “coupon” is a bond that is bought for a discount to the face value and pays no interest until the coupon comes due. So, I paid less than \$14,000 for it, and will get \$14,000 in June of 2010.

To figure out the fees I’m charged for trading this bond I first checked what I could get for it if I sold it: \$13,438.14. The cost of buying another identical bond is \$13,532.82. So, the total fees charged for buying and selling this bond are \$94.68. I’ve actually done this calculation twice about a week apart to see how stable these costs are. The total fees the first time were \$96.01. Based on just two data points, the total cost of a buy and sell is about 0.7% for this bond.

Let’s compare this to the costs of trading \$14,000 worth of XIU, an index ETF of the S&P/TSX 60. I would pay \$9.95 for each trade, and based on 1000 shares and a bid-ask spread of \$0.02, the total spread cost of a buy and a sell is about \$20. So, the total fees are \$39.90. Based on this example, trading the bond is nearly 2.5 times more expensive than trading the index ETF.

If any readers would care to check on their costs of trading bonds with their brokers, I’d like to try to get a picture of bond trading costs.

1. MJM

I have also tried to get a handle on the cost.

Another difference from purchasing stocks, seems to be the breadth of the offering or lack of same. With an RSP account at TDWaterhouse it appears that "offering" is much more limited than I expected or have previewed on CBID

Thoughts?

q

2. According to the site listed below, the commission varies with the term of the bond (longer-term bonds carry a higher commission), with the size of the transaction (very large transactions - \$100,000 or more - can get a better deal), and with the dealer. The going rate for commissions for \$100 par value strips should be around \$0.25 to \$0.50 for shorter terms and up to \$1.25 for longer terms.

I happen to use TD Waterhouse as my on-line discount broker. Through their on-line "Fixed Income Centre", you can see their on-line prices for buying and selling various fixed income products.

Looking at a Province of British Columbia strip maturing June 9th, 2010 for \$100 par value, the sell/buy quotes are \$94.924/\$96.250 for a spread of \$1.326, which is about twice the spread that you were quoted.

Looking at a British Columbia strip maturing Sepember 8th, 2019 for \$100 par value, the sell/buy quotes are \$56.336/58.811 for a spread of \$2.462.

These quotes seem about twice as high as the going rate for commissions.

http://www.telusplanet.net/public/kbetty/fbonds.htm

3. Q: The offerings at BMO Investorline seem somewhat limited as well, but more than adequate for my needs.

Blitzer68: I wonder if commissions vary with the client as well. It's common for clients with minimum balances to get lower stock trade commissions. Maybe the same is true of bonds? Your data seem to confirm that trading bonds is significantly more expensive than trading stocks.

4. The cost on trading stocks and bonds is only half the story. Of importance is the cost of trading and owning the stocks and bonds. In this case, you need to look at the MER on the stock ETF.

The commission to buy a bond and hold it to maturity can be considered half the bid-ask spread. Given costs on \$100 par value strips ranging from \$.25/2 to \$1.25/2 for short to long term maturities, the impact on bond yields will come in around 0.5% for short term bonds to 0.02-0.05% for long term bonds.

The commission cost for XIU is the half the bid/ask spread plus the yearly MER. Here half the bid/ask spread is 0.017% and the MER is 0.17% for a total of 0.187%

A more interesting question is to determine whether you're better off, for your bond allocation, owning individual bonds or a bond fund or ETF. This will depend on what types of bonds you want to own, their duration, and when you plan on cashing them in.

5. Blitzer68: I agree with you that taking into account all costs is important for investors making decisions about their savings. If we focus specifically on the fees involved in trading, I'm not sure what justifies the much higher costs of trading bonds vs. stocks. There may be good reasons, but the high variability of bond trading costs makes me suspicious that the fees are high because few people notice them. There is no point in competing on bond trading fees if investors don't care much.

6. Yes, it seems kind of like currency conversions. When I first started investing, I didn't even think of the cost of selling a Canadian stock and buying an American stock with the proceeds. Now I'm very aware of the cost, and I avoid it whenever possible.

A mitigating factor that reduces your bond commissions is that if you hold them to maturity, you shouldn't have to pay a commission to sell. A stock will incur a second commission to sell. Still, trading stocks these days is very cheap, especially when the bid-ask spread is narrow. Of course, it's been tough to make money trading stocks lately, but that's a whole other ball of wax.

7. James,

I imagine that the volume of trades is much lower for bonds versus stocks. Like anything, higher sales volumes tend to bring prices down. I wish the commissions for bond trading were lower too.

8. What you are missing is that the firms need to charge a higher spread because they are taking on the risk. For stock trades they are just "brokering" the transaction and take on no risk. With bonds, the firms must hold it in their inventory in order to provide it to you. If bond prices move against them, they lose.

Another thing, you will never see the commissions on bonds posted. Period. End of conversation. I've been a broker at two of the largest firms in the country for 15 years. Over the years, I have heard rumblings about making bond costs more transparent but it gets knocked down every time. And it's not the piddly \$14,000 2yr strip that we are concerned about. The commission won't buy me a coffee at Starbucks. However, the \$500,000 5yr strip, which pays out \$6,250 is enough to keep every top broker in the country onside with ensuring that it remains simply part of the spread.

9. Anonymous: Thanks for the inside view. You are right that the brokerage is taking on risk and needs to be compensated for it. I hadn't accounted for this. However, it seems that the spreads are higher than necessary to compensate for this risk. As evidence for this, I would point to your example of the juicy \$6250 on a \$500,000 5-year strip. I can see why brokers like to hide their commissions in the spread. The reason broker interests carry the day is that customers aren't complaining enough about bond trading costs. I'm trying to do my small part to raise awareness and maybe ultimately change things.