Bond Funds

Bonds are similar to loans, and they are issued by government agencies, municipalities and companies. An issuer promises to repay the “face value” of the bond when it matures and to make specified interest payments until that time. Once it is purchased, a bond can be traded at a price that may differ from its face value because of fluctuating interest rates, and at maturity, it may be worth more or less than the original purchase price.

Bond mutual funds are investment companies that were established to manage a portfolio of investments containing individual bonds, and possibly other securities. As an investor, you would purchase shares in the bond fund and a professional money manager will use your investment to sell and buy bonds that form the company’s portfolio. You will have greater investment options than the individual investor working alone, and the minimum investment required is usually quite reasonable.

Bond funds are a popular way for Americans to invest, and they are a special favorite with retirees and senior citizens because they find the advantages of stability and a steady income appealing. Unlike other bonds, however, the dividends are not fixed, and there is no maturity date.

A bond fund’s exposure to risk is lessened by the diversification of bonds within the portfolio, and the law stipulates that, on any business day, the mutual fund must be prepared to buy back its shares at full value, and this liquidity is a key feature.

There is still an element of risk

While individual bonds in the mutual fund portfolio are privately insured or guaranteed by the federal government, the mutual fund investment itself may rise or fall at any time, whether you invest through a bank, a financial planner, a brokerage firm, an insurance agency or directly. Possible loss of principal is a definite disadvantage you should consider.

The risks that might cause the value of the shares you purchase in a bond fund to decline include prepayment risk, interest-rate risk and inflation risk. (The latter should be kept in mind if you plan to make such an investment because of a bond fund’s stability.) Interest rates fluctuate, and they are related to the fund’s “average portfolio maturity”¬—the average of all the bonds’ maturity dates found in the pool. Prepayment risk is a possibility when the mutual fund invests in mortgage-backed debt, and you may not receive any interest payments in the future. Also, the value of your shares can decline if the bond issuer fails to meet its payment obligations.

On the positive side, mutual funds are regulated by the U.S. Securities and Exchange Commission (SEC), and they are obliged to follow strict anti-fraud regulations, measure up to established operating standards, and provide complete information to any one interested in investing with a prospectus.

Rewards are also possible

As a rule, after you make an informed decision, such an investment will entail greater rewards than a similar investment in certificates of deposit (CDs) or a money market fund.

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