Looking at AGG bond ETF from an individual’s POV. Is each coupon within the ETF distributed as a dividend? It looks like ‘dividends’ are paid pretty frequently. Because it’s a dividend (and not a coupon payment) are these tax differently than owning a bond outright? Is it better (costs, diversification) to invest in ETF’s as opposed to individual bonds?
No, just like a mutual fund the coupons are rolled into an income component and paid out as dividends on a regular basis. Both dividends and coupons are taxed as ordinary income. Obviously you have better diversification with an ETF, but you can’t manage the credit quality, duration, sector allocation, etc. like you can by using several individual bonds. Depending on how much you’re looking to invest, it would probably be cheaper to go the ETF route.
AGG does track the Lehman (Now Barclay’s Aggregate Bond Index), so it’s pretty well diversified and is supposed to represent the broad bond market. Assuming that’s what you actually want to get, you probably don’t have to worry too much about your sector and duration representation. If you are looking for a less diversified fund, then it’s more of a problem.
Not all cupons are distributed since the fund has costs. The type of income received should keep it’s characteristics - the distribution is still interest not dividend (there are some specialized funds that turn interest payments into capital gains but not regular ones like AGG) Etfs are better to use because of diversification and cost (especially for small investors) but you lose some of the tactical approach (you can choose more specific funds if you have a view on duration/credit targets you want to reach)