What do you pay when you purchase a bond? “No idea” is the likely answer. That will soon change. New rules require full disclosure of the broker’s mark-up. With this information, your purchase decision may change.
Prior to purchasing a bond, you probably consider how safe it is and its yield. But until now, you didn’t have access to another key decision-making component – the mark-up you were paying when buying the bond. Soon that will change. And the impact could be significant!
The New Mark-up Disclosure Rule
As an investor, you only know the total price for the individual municipal bonds you buy or those purchased for you by an advisor. The “mark-up,” or fees you are charged, are not separated out. Instead, they are rolled into the total price paid. There is little transparency in the reporting of the transactions. For example, if you bought a bond for $20,000, your transaction would only state you paid $20,000 for the bond. You’d have no indication that the firm selling you the bond bought it for only $19,500 and you essentially paid the firm $500 in fees.
But that’s changing. The main governing body of the municipal bond market, The Municipal Securities Rulemaking Board (MSRB), is issuing a new “mark-up disclosure rule.” Starting May 14, 2018, the “mark up” or the fee charged to purchase a municipal bond must be available information to the investor.
The High Cost of Buying Bonds
So why is this new disclosure law so important? Many investors assume the bond market works similarly to the stock market. They may believe that paying a fee or commission to buy a bond is similar to paying a fee or commission when stocks are purchased. Because stock commissions are fully disclosed, such fees have been reduced over the years, to the benefit of the investor.
This is far from the case for bonds. Investors may be shocked to learn they are paying hundreds or thousands of dollars in mark-ups (depending on the size of the transaction) every time a bond is bought or sold. That’s a lot of money to leave on the table.
The Impact on Investors
This new disclosure rule will give investors more information when considering the purchase of a bond - allowing for a more informed decision. How will this change the analysis and decision making process?
Many investors consider only a few factors when buying a bond, namely how safe is the bond and how much does it yield. Now investors will get to know the amount of the mark-up or fee for buying a particular bond. For example, let’s say you buy a bond yielding 3 percent for the next five years. Sounds good, right? But if the mark-up for buying the bond is 2.5 percent, you may be losing close to one year’s worth of interest!
Investors will now need to consider if buying individual bonds and holding them until maturity is actually the most cost-effective option. Using a low-cost mutual fund may be a better solution, depending on the situation. A mutual fund can use its pricing power to buy bonds at very low mark-ups and pass those savings along to their investors. As with everything, there are pros and cons to owning a bond mutual fund versus owning individual bonds. Now you’ll have the mark-up information to guide you in making your decision.
This disclosure rule is long overdue for investors. It’s hard to make an informed decision when a key piece of information is not disclosed. Starting May 14th, that will change. For buyers of individual municipal bonds, this is good news. This new disclosure rule gives you the option of rethinking how you want to invest in bonds for your portfolio. In the future, this new fee transparency could drive down the size of mark-ups as investors become aware of the cost of these fees and look for other options or lower-cost solutions.
Prior to implementing any investment strategy referenced in this article, either directly or indirectly, please discuss with your investment advisor to determine its applicability. Any corresponding discussion with a Bedel Financial Consulting, Inc. associate pertaining to this article does not serve as personalized investment advice and should not be considered as such.