How Do Bond Prices & Yields in Mutual Funds Work?
Mutual funds are a popular choice for investors looking for bond exposure. According to the Investment Company Institute bond mutual funds hold over $2 trillion in investor assets. The total return that bond fund investors can earn is a combination of the changes in bond prices and the interest the bonds pay toward yields.
Other People Are Reading
-
Features
-
A bond mutual fund owns a portfolio of bonds selected to meet the fund's investment goals. Some of the standard features of bonds are that they pay a fixed amount of interest every six months and have a set maturity date when the bond face amount will be returned to the bond holder. After they are issued, bonds trade on the secondary market, where their prices fluctuate based on current interest rates and the credit quality of the issuer.
Function
-
The main factor that affects bond prices is changing interest rates. Most bonds pay a fixed rate of interest and if interest rates rise the value of a bond will fall to keep its current yield in line with current rates. Falling interest rates cause bond prices to increase. The value of the bond portfolio of a bond mutual fund will rise and fall with changing interest rates. Bond price changes are reflected in the net asset value or share price of the funds. Mutual funds holding longer-term bonds will fluctuate more in value than funds owning shorter-term bonds.
-
Yields
-
Bond funds pay out the interest earned from the bonds in the portfolio as dividends. Most bond funds pay a monthly dividend. Bond fund yields are reported two ways. The SEC 30-day yield is computed using the method directed by the SEC. This yield is comparable to the yield-to-maturity of an individual bond. The SEC yield is what an investor could expect to earn over several years if the bonds in the portfolio did not change. The distribution yield is the current rate of the dividend payouts. This is the interest the portfolio earns each month that is paid out to the shareholders.
Considerations
-
To achieve higher yields, a bond fund must either own longer-term bonds or bonds with a lower credit quality. In a period of falling interest rates and a strong economy, these funds will pay high yields and have rising share prices. If rates are increasing, a fund with shorter bond maturities will have a more stable share price and be able to increase the distributions quicker as rates rise.
Potential
-
Bond mutual funds provide investors access to professionally managed bond portfolios. Investors can choose to receive a monthly income check from a fund or reinvest the dividends into more shares, compounding the growth.
-
