What is a Bond Fund?

1 What is a Bond Fund?

A bond fund is a mutual fund with a portfolio of bonds. As with a mutual fund, many investors pool their money and the fund is managed according to an identified strategy. The objective of a bond fund is to provide income that is stable, with little risk to the investment of the original capital.

2 Why Invest in a Bond Fund?

When you invest in a mutual fund, you’re paying for the expertise and direction of the fund manager. If you want to invest in bonds but lack the time or desire to do directed research, a bond fund may be the way to go. The bond market behaves differently from the stock market, and is complex for those new to bond investments. 

3 Why Not Invest in Bonds Instead of a Bond Fund?

You will likely be able to buy into a bond fund for less of an initial investment than by purchasing individual bonds. Also, in a bond fund, volatility and risk of particular bonds are minimized by incorporating many bonds into the fund portfolio. If one bond defaults, for example, the effect within a fund portfolio will be much less than if you owned that particular bond alone. In a bond fund, the risk is spread across the portfolio holdings. 

4 What are the Different Types of Bond Funds?

· U.S. Government Bond Funds: The portfolio of these funds consists of bonds with the federal government as issuer. Credit risk is low, so performance and yields are less than other bond funds.

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Corporate Bond Funds: The portfolio of these funds consists of bonds with corporations as issuers. 

· High Yield Bond Funds: These funds invest in smaller, relatively risky companies, as well as larger companies that don’t have a premium credit rating. The risk to the investor is greater in this kind of bond fund, so yields are higher than a more conservative bond fund. 

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Municipal Bond Funds: These funds have a portfolio of bonds that have been issued by government entities. Dividends are federally tax-exempt, and may be state tax-exempt in certain instances.

· Mortgage-Backed Securities Funds: These funds invest in bonds that are issued by governmental mortgage-related entities such as the Government National Mortgage Association (Ginnie May), the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac).

5 How Do I Choose a Bond Fund?

· Research fund expenses, and make sure they are relatively low. Bond index funds will usually have lower expense rates than municipal bond funds or high yield bond funds (also known as junk bond funds). 

· Consider the impact of bond maturity lengths on the performance of the fund. Short- or medium-term maturities may yield less, but will also result in less volatility over time. Long-term bond maturities have more time to be impacted by marketplace interest rates, and this can affect the fund yields positively or negatively, depending upon interest rate trends.

· Gauge high yielding funds. These funds may include riskier bonds with less creditworthiness than you may be comfortable with.

6 How Do I Assess the Risk of Bond Funds?

The inherent risk in a bond fund will depend on the type of fund you are considering. Look at individual bond ratings in the fund portfolio. Look at bond maturity length – longer length implies greater volatility. A high yield (junk bond) fund will be a riskier investment than a government bond fund.

7 Are Bond Funds a Popular Investment?

Bond funds are the second most popular type of mutual fund. Investors may include bond funds in their portfolio to balance the risk of stock investments.

8 What Other Criteria Can I Use to Choose a Bond Fund?

The following questions are useful when choosing a bond fund: What is the minimum amount required to buy into a bond fund? What is the fund’s expense ratio? Is the fund a load fund (meaning a fee is taken up front) or a no load fund? 

9 Are There Online Resources Where I Can Compare Bond Funds?

The Web site http://www.morningstar.com is one example of an online resource that lets you enter fund criteria and compare several funds at once. On the site, go to “Funds” and then to “Fund Selector” under “Tools.”

10 Where Can I Find More Information About Bonds and Bond Funds?

· Bond and Income Funds: http://www.sec.gov/answers/bondfunds.htm
· Government Bonds: http://www.sec.gov/answers/treasuries.htm
· Mortgage Backed Securities: http://www.sec.gov/answers/mortgagesecurities.htm

Municipal Bonds: http://www.sec.gov/answers/bondmun.htm