What Are Bond Funds?
A bond fund is a mutual fund whose portfolio is made up of mostly bonds or other types of debt securities. Debt securities are securities representing a loan given by a bond holder to an issuer. In exchange for the loan, the issuer vows to pay interest and to pay back the entire debt by a specific date. Basically, a bond is nothing more than a loan between the issuer (think "lender") and the bond holder (think "borrower").
Typically, the federal and local government, mortgage securities holders, or large corporations issue bonds so they can raise money from the general public in order to finance new projects, new ideas, or just keep afloat.
A bond fund is just another means of investment. Like most investments, there are risks involved. Most people will tell you the risks are moderate—but there are risks.
Some of the risks include:
- Credit risk
- Prepayment risk
- Interest rate risk
Credit risk is when the issuers of debt default. Prepayment risk does not apply to all bonds, but occurs when the bonds are paid off in a time of market decline and general interest rates are lower. Interest rate risk is based on the interest rate markets—you may buy a bond at a specific rate, but based on market conditions that rate can drop and the value of the bonds will decrease.
Bond funds are most often purchased for growth and income aspects in a portfolio. There are many different types of bond funds, municipal bonds, government bonds. Depending where you live, you may be able to use bond funds to help defer taxes. Talk to your accountant to see which, if any, taxes you can become exempt from due to your bond funds.
Since there is such a wide range of bonds available, be sure to speak to an experienced broker. With all investments there are fees and risks; make sure you do your homework before purchasing any bond funds.
