What Is a Bond Fund, exactly?
A bond fund, sometimes known as a debt fund, is a pooled investment vehicle that typically invests in government, municipal, corporate, and convertible bonds, as well as other debt instruments including mortgage-backed securities (MBS). The basic purpose of a bond fund is to provide investors with monthly income.
Most investors can choose between bond mutual funds and bond exchange traded funds (ETFs).
• A bond fund is a type of mutual fund that invests primarily in fixed-income assets.
• Bond funds offer investors immediate diversification for a minimal initial commitment.
• A long-term bond has a higher interest rate risk than a short-term bond due to the inverse relationship between interest rates and bond prices.
Bond funds: An Overview
Bond funds are mutual funds that only invest in bonds. For many investors, investing in bonds through a bond fund is more cost-effective than purchasing individual bonds. Bond funds, unlike individual bonds, do not have a maturity date for principal payments, therefore the amount invested might fluctuate over time.
Investors also benefit from the interest paid by the mutual fund’s underlying bond holdings. Interest payments are made monthly and reflect the mix of the
fund’s various bonds, therefore the interest income distribution will change monthly.
When you invest in a bond fund, you are placing your money into a pool that is managed by a portfolio manager. A bond fund manager often buys and sells bonds based on market conditions, and rarely retains bonds until they mature.
Types of Bond Funds
Most bond funds are made up of a specific form of bond, such as corporate or government bonds, and are further divided into short-term, intermediate-term, and long-term maturity periods.
Only the safest bonds, such as government bonds, are included in some bond funds. Investors should keep in mind that US government bonds are deemed to have the best credit quality and are not rated. Bond funds that specialize on US Treasury securities, such as Treasury inflation-protected securities (TIPS), are the safest but have the lowest possible returns.
Other funds only invest in the riskiest types of bonds, such as high-yield or trash bonds. Bond funds that invest in more volatile bonds have a larger potential for profit.
Bond Fund Advantages
Bond funds are appealing investment options since they are typically easier to participate in than buying individual bond instruments that make up a bond portfolio. An investor simply has to pay the yearly expense ratio, which covers marketing, administrative, and professional management expenses, when they invest in a bond fund. Alternatively, you can buy many bonds and deal with the transaction charges connected with each one separately.
Bond funds offer investors immediate diversification for a minimal initial commitment. Because a fund often invests in a variety of bonds with diverse maturities, the impact of any single bond’s performance is mitigated if the issuer fails to pay interest or principal.
Another advantage of a bond fund is that it gives you access to professional portfolio managers who can investigate and assess bond issuers’ creditworthiness as well as market conditions before purchasing or selling. When an issuer’s credit rating is reduced or when the issuer “calls,” or pays off the bond before its maturity date, a fund manager may replace bonds.
What Is a Bond Fund, exactly?