Bond Mutual Funds

Hello there to all mutual funds enthusiasts. If you are here, I believe you are planning to buy some bond mutual funds. Fortunately, I am focusing on Bond Mutual Funds in this hub and by some way or another you have found me! You may ask, what exactly are Bond Mutual Funds? In my other hub, I have talked about the definition of Mutual Funds. If you have not read it, please do, as it will not only allow you to understand Mutual Funds or Unit Trusts better, but there are also some recommended books that you can purchase to increase your understanding of Mutual Funds. So once you know what are Mutual Funds, you can read this hub to find out what are Bond Mutual Funds.

To know more about Bond Mutual Funds, I think you first have to understand what bonds are. I am not talking about James Bond or Bondage or links. Let us start the topic with a simple analogy. Have you ever ran out of money and had to borrow from someone? I guess so, since these days there usually enough money to go around hahaha. It is not surprising to know that companies and even governments need to borrow money sometimes. Being governments and big companies, the amount of money that is borrow is enormous. Instead of borrowing, they issue Bonds. And who buy these Bonds? People like you and me!

Bonds are like loans, only that now you are the lender. The companies or government which borrow the money from you, have to agree to pay you back the amount they borrowed. In addition, they have to pay you some extra money in the form of interest for borrowing your money. These interest payments are known as coupons and are usually paid at regular intervals such as every year. The full amount that is loaned out, known as the principal, is returned back to the lender, in this case you, at a certain date. This date is called the maturity date. The main difference between stocks and bonds is that the government or company guarantees to pay you back your principal, plus interest. You know exactly how much you are going to get back, and when you are going to get it.

So after hearing the above, do you think Bonds make good investments? You should now understand that bond mutual funds invest in both bonds and other debt securities. If you are interested to purchase bonds but lack the time or investment capital to buy them, perhaps you can purchase a Bond Mutual Fund or Bond Unit Trust. A Bond Mutual Fund or Bond Unit Trust is basically a collection of different types of bonds. Instead of buying an individual bond, you are buying into a diversified portfolio of bonds when you purchase a Bond Mutual Fund or Bond Unit Trust. This is a good strategy as you will be able to diversify your investment with some fixed-income exposure. Even 'growth' investors invest in bonds when the time is right!

For investors who are interested in Bond Mutual Funds, they should pay particular attention to interest rates. This is because rising interest rates can cause bond prices to fall. The reverse is also true, falling interest rates can cause bond prices to rise. The reasoning behind this is as such: as interest rates fall, people are willing to pay more money for the bond because the fixed coupon paid out by the Bond will offer a higher return compared interest income. If interest rates rise, people are less willing to hold on to bonds because the interest income would be higher than the fixed coupon paid out by the bond, hence leading to a fall in bond prices (and Bond Mutual Fund prices as well). This is known as capital depreciation.

There are many different types of Bond Mutual Funds. Bonds with less than 1 year to maturity are known as money market instruments. Fortunately again, there are mutual funds or unit trusts which invests solely in these money market instruments, known simply as Money Market Mutual Funds. I will explore this in another Mutual Funds Hub of mine. Bonds and money market instruments are also known as 'fixed-income' investments. This term is given to these investments as they pay out a regular income in the form interest coupons to investors.

As for the main types of Bond Mutual Funds, there are basically three types: U.S. government bond funds, municipal bond funds, and corporate bond funds. The returns of these bond funds differ because the bonds dealt with by each of the Bond Mutual Funds differs. Some bonds would accord higher risks while others lower.

U.S. government bond funds invest in debt securities that are issued by the United States government and its associated agencies. These funds are regarded as the safest as the underlying debt securities are backed by the United States government. Do you believe in the government of the United States? If yes then maybe you can try purchasing US Government Bond Mutual Funds. These funds invest in debt instruments such as Treasury bills, Treasury notes, Treasury bonds, and mortgage-backed securities issued by government lending agencies, an example of which is Fannie Mae. However there are still a certain degree of risks; this is from the fluctuating interest rates and inflation. Do also take caution that the US Government Bond Mutual Fund itself is not backed by the United States government.

Municipal Bond Mutual Funds invest in debt securities issued by American state and local governments to pay for local public projects. Such public projects include public bridges, schools, roads and highways. Municipal Bond Mutual Funds are popular among investors with high incomes because they are not subjected to federal income taxes. Sometimes, they are exempt from state taxes as well. This is if you purchase a Municipal Bond Mutual Fund with most of its holdings in your home state. That can result in significant savings. Similar to U.S. Government Bond Mutual Funds, the underlying securities in Municipal Bond Mutual Funds are backed by the government and thus are considered to have high credit ratings. However, risk still abounds; municipalities can declare bankruptcy. Municipal Bond Mutual Funds are thus riskier than US Government Bond Mutual Funds.

Besides the above three types of Mutual Bond Funds, there are other types of Bond Mutual Funds that exist in small quantities. Some of these Mutual Bond Funds include Zero-coupon Bond Mutual Funds which invest in zero coupon bonds, International Bond Mutual Funds which invest in bonds issued by foreign governments and corporations, Convertible Securities Mutual Funds which invest in bonds that may be converted into stock and Multi-Sector Bond Mutual Funds that invest in all the different kinds of bonds: corporate bonds, municipal bonds, international bonds etc. I shall not delve too deeply on these types of Bond Mutual Funds.

Bond Mutual Funds are considered as "low risk" investments that will provide stability to a portfolio that mainly consists of stocks and shares. Bond Mutual Funds are considered as conservative investments that aim to protect the principal you have invested while paying out a regular income. So if you are more of a conservative investor, you will receive monthly dividends from the Bond Mutual Fund, similar to the coupons issued for Bonds. Similar to other types of mutual funds or unit trusts, bond funds have a net asset value (NAV) which is the price that investors pay or receive when they buy or sell the Bond Mutual Fund. This value increases if there is any capital appreciation in the prices of the bonds within the portfolio of the Bond Mutual Fund.

However, as with all other investments, do take note that Bond Mutual Funds are not risk free. Bond Mutual Funds are still subject to the same credit and interest rate risks as regular bonds. Government bonds are relatively safer than companies, however, it is still possible for governments to fall. As for companies, although the company has guaranteed to pay your principal back, they can go bankrupt. However, since the Bond Mutual Fund's investments are spread out among many bonds (to mean diversified), the overall risk is usually lower. Bond Mutual Funds are also more liquid investments compared to individual bonds since Mutual Funds can be bought and sold much more easily.

To summarise, there are two reasons why investors choose to buy Bond Mutual Funds, that is for the income generated by coupons (in terms of dividends from the Bond Mutual Fund) as well as diversification. Bond Mutual Funds usually pay higher dividends compared to money market mutual funds or savings accounts. In addition, they usually pay out dividends even more frequently than individual bonds.

Unlike US Government Bond Mutual Funds or Municipal Bond Mutual Funds which comprise of Bonds issued by the Government, Corporate Bond Mutual Funds are comprised of bonds issued by corporations. Therefore the bonds found in a Corporate Bond Mutual Fund are not backed by any government institution. It is thus riskier compared to the previous two types of Bond Mutual Funds as the corporate bonds could default if the companies that issue them run into financial trouble. With bigger risk however, you can get a bigger reward; the coupons or income paid out by Corporate Bond Mutual Funds are usually much greater than those paid by Municipal or U.S. Government Bond Mutual Funds. The safest would be the Investment-grade Corporate Bond Mutual Funds which invest only in creditworthy companies.