You point. You click. It's that easy to trade stocks online. If only it were so simple for bonds. While investors everywhere know how to get the lowest commissions for Web stock trades, finding the same deals for bonds is more difficult. The reason has little to do with the Internet and everything to do with the nature of the bond market.
The bond universe is vast and extremely fragmented. More than 4 million bond issues are available in the U.S. alone, and there is no central exchange, such as the New York Stock Exchange or the Nasdaq, on which they trade. So prices often vary from dealer to dealer, and doing research is hard. It's also difficult to know whether you're getting a good price. Most bond brokers embed their trading commissions--or "markups"--into the bond's price, so you can't tell how much you paid for the trade. The only way to know if you scored or got taken is to compare the yields for the same bond at different brokers. These same problems exist both online and off.
That said, the Web does offer cost savings to investors who do their homework. About the closest thing to a no-brainer is TreasuryDirect at www.treasurydirect.gov, which allows you to buy Treasuries at government auctions with no transaction fees. Although Treasury prices are sometimes lower in the secondary market, one key advantage of buying at auction is that you know you're getting roughly the same price as all other investors, big and small. At the Treasury's savingsbonds.gov, you can buy the old-fashioned savings bonds as well as the newer, inflation-adjusted I-Bonds, which now yield 7.49% (though the rate will be reset Nov. 1).
For other types of bonds, you have to comparison-shop. Your first stop for information should be the Bond Market Assn.'s www.investinginbonds.com. The site has many educational tools, articles about bonds, and links to other sites. But of crucial importance is the Daily Muni Bond Summary. This section offers a comprehensive price breakdown of the prior day's most actively traded municipal bonds. By looking at the daily trading range you can figure out whether your broker's prices fall in the high or low end of the spectrum.
For instance, BUSINESS WEEK recently found one broker, BondAgent.com, offering AAA-rated muni bonds issued by the New York State Energy Research & Development Authority at $101. (In bond terms, $101 is actually $1,010 for a bond with a face value of $1,000.) At $101, the yield was 5.41%. The Muni Bond Summary showed a price range of $96.50 to $101 that day, meaning that BondAgent was selling at the highest price and lowest yield. In contrast, another broker, MuniDirect.com, was offering the same bond for $98.50, yielding 5.62%. Meanwhile, TD Waterhouse Group (TWE) was selling it for $99, yielding 5.58%. Unfortunately, since the muni summary's prices aren't live, this knowledge comes after the fact. But you can still use the site before you buy a bond to see which brokers consistently come up with the best prices. The Bond Market Assn. does offer hourly price updates of recently issued Treasuries.
The best strategy is to open multiple online accounts and use one as your home base. Web brokers such as DLJdirect, Charles Schwab, and E*Trade offer a good selection of bonds (table).
If you're also registered with specialty brokers--such as MuniDirect, eBondTrade, BondsOnline, Tradebonds.com, or BondAgent.com--you can shop around for the bonds you want, buy from the broker with the best price, and arrange to have the bonds delivered to your main account for free.
Of nine brokers that BUSINESS WEEK examined, only DLJdirect and MuniDirect disclose all commission costs. DLJ charges $3 for each $1,000 corporate, muni, or agency bond, while MuniDirect charges $2.50 to $5 per bond, depending on the order. Other sites mark up their bonds, but the markups are generally less than off-line brokers, according to Todd Eyler, an analyst at Forrester Research who recently completed a study of online trading. "As an individual investor, you would traditionally pay a 5% commission for a bond at a full-service broker," he says. "It would take a year's worth of interest to recoup that if you bought a municipal bond. At sites such as eBondTrade, [the markup] is a fraction of 1%." When purchasing long-maturity bonds, say, 10 years or more, it's better to use flat-rate brokers such as DLJdirect. That's because brokers who make their money through mark-ups charge more for long-term bonds.
GUARANTEED INVENTORY. It's also important to know what trading platform a broker is using. Since no central bond exchange exists, many online brokers use electronic trading platforms to link themselves to other dealers. The broker with the best platform has access to the most bonds and can usually find the best prices, regardless of the commissions they charge. E*Trade (EGRP), DLJ (DLJ), and Waterhouse all use BondDesk.com, which has access to 60 dealers and about 7,000 bonds. It has a big advantage in that many of its bonds are "live and executable," meaning prices are real-time and the inventory is guaranteed to be there. Another popular retail platform, Bond Express, has 15,000 bonds, but they are subject to dealer availability. So you may go to purchase a bond and find it's not available at the price quoted.
Some online brokers also have their own stash of bonds, which they sell directly to investors without outside dealers. That allows them to guarantee availability. One such broker is eBondTrade, which offers 450 of its own muni bonds. E*Trade and Waterhouse sell investors bonds from their own inventories as well as acquiring them from others. Schwab (SCH) sells from its inventory but is also building a new platform, called ValuBond, that should go live in December. ValuBond is planned to give investors a crack at all dealers' inventories, not just Schwab's.
All told, bond investors can find better deals online than off. It just takes more effort than pointing and clicking.