About Bond Mutual Funds

Bond mutual funds are a way to invest in bonds without buying them individually. Bond mutual funds package bonds together, usually with a specific investment philosophy, market sector or combination in mind. They are also called "income funds" since they provide income by paying dividends. This differs from many stock mutual funds that focus on share price growth.

Identification

Bond mutual funds are viewed by many investors as a more conservative place to put money than stock mutual funds. Bonds are promissory notes to repay borrowed money with interest. Bond mutual funds invest in a variety of bonds with a specific investment goal. Some bond mutual funds focus on government bonds. Some concentrate on riskier bonds with higher returns. Others specialize in securities backed by debt like mortgages.

Considerations

Bonds are only as good as the borrower's ability to pay the loans back. It is therefore important to consider the quality of bonds in a bond mutual fund. If those who owe money on a bond default, the bond mutual fund will lose money. If they repay the debt early the bond mutual fund may need to invest in other bonds with lower returns. Longer maturity bonds can also fall in value with fluctuating interest rates. This can decrease the value of your bond mutual fund when you sell.

Features

Investors can find out how reliable a bond is expected to be by looking at its rating. Several companies assign letter grades to bonds based on reliability and credit worthiness. AAA is the highest rating suggesting that the bond is very likely to be repaid on time and in full. Bonds with a C rating are considered unreliable and called "junk bonds." Treasury bonds backed by the United States government have no ratings. They are considered the safest bonds of all. Many bond mutual funds guarantee investors that they will only buy AA bonds or better.

Warning

There are significant risks to bond mutual fund investing. One of the more vivid examples of this is the home mortgage crisis of 2008. In the years prior to the crisis, it was once widely believed that bond mutual funds with mortgage loans were safe because they provided consistently good returns. When it was revealed that mortgage defaults were pervasive, agencies like the Federal National Mortgage Association, known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, known as Freddie Mac, were on the verge of collapse. In September 2008, the Federal Housing Finance Agency seized control of Fannie Mae and Freddie Mac to prevent the entire economy from imploding.

Benefits

Investors who pay high taxes can benefit from tax exempt bond mutual funds. Some municipal bonds are tax free in many states. Some of are also exempt from federal taxes. This is an additional incentive to invest in bond mutual funds since lower taxes contribute to bottom line gains.