Investing In A Bond Fund?
Thursday, November 23rd, 2006
Many rookie investors assume that Bond Funds are a convenient alternative option to investing in bonds directly. After all, the fund invests in Bonds; and they are able to diversify better, as well as get expert advice. In addition, they would have investment experience, which ought to make the returns better?
Bond funds can be quite different from bonds themselves because they are not really fixed-income investments. Even when a mutual fund’s invests only in bonds, the fund itself has neither a fixed yield nor a contractual obligation to give investors back their principal at some later maturity date. In addition, the risk-return profile keeps changing as the fund trades bonds.
While bond funds do get fixed returns from the investments, a significant part of the returns are likely to be from trading bonds. As bond prices fluctuate with changes in interest rates, there can be substantial gains or losses.
There could be convenience in investing through a bond fund, especially if the fund itself focuses on specific types of bonds; tax free municipal bonds, or triple A corporate bonds. This is because the entry investment is a lot lower; if you had to build a diversified portfolio of these bonds, you would need to have at least $100,000 to invest. A good quality bond fund from Vanguard or other fund managers would require a starting investment of $5,000.
Keep in mind though, that the risk - return profile is quite different for a fund. These are more akin to equity funds than to bonds themselves.
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