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The Good and Bad of Bond Funds

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Bond Funds

What Are Bond Funds?

Bond funds are types of mutual funds. These collective investments differ from other funds because they primarily concentrate their investments on bonds. In some cases, a bond fund is composed exclusively of bond investments. There are four main types of these funds.

• Government bonds — These funds mostly buy U.S. Treasury bonds. While they are popular for their safety, they are not very profitable because the yields are low. The low yields are caused by the safety of these investments.

• Municipal bonds — Funds that focus their investments in these bonds are often exempt from federal taxes.

• Corporate bonds — These funds carry a higher risk because their funds are insured by companies rather than governments.

• Mortgage bonds — Government loan agencies, such as Fannie Mae and Freddie Mac, issue such bonds.

Advantages and Disadvantages of Bond Funds

It may not seem apparent why a bond fund might seem superior to investing directly in bonds themselves. Some investors prefer these investment schemes for the management provided. This facet of a bond fund saves investors from having to do their own research.

Other investors appreciate the diversification, even though the differences between the yields of distinct bonds are much less than those found between stocks. The liquidity of these investments is what draws many investors back during troubled times in the market. They know that they can buy a bond fund and wait until trouble passes. Then it is easy to sell it and reinvest in stocks that are more active.

There are drawbacks to bond funds, especially when compared to individual bonds. Funds usually charge fees for purchases that are calculated using the total investment amounts. The yields with bond funds vary because they are spread across several different bonds rather than keyed in to one. Since fund managers change the nature of the investment over time, the net asset value of bond funds will change rather than remain at a guaranteed rate.

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