• Smaller block trades, versus larger dealer block trades, have higher transaction costs, in relative terms to the face value of bonds trading as markups are applied on both the purchase and sale of bonds to and from individual market participants.
• Municipal bond retail investors incur higher markups and therefore have higher transaction costs than retail investors buying or selling corporate bonds.
• As a result of these markups, buying and selling retail-size bond lots is demonstrably less efficient than buying or selling shares of an exchange-traded fund (ETF) or a mutual fund, which can buy and sell bonds with larger block sizes and lower markups.
• In a low-yield environment, retail transaction costs can be a significant cause of erosion of potential returns.
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.