How to Evaluate Bond Funds
Bond funds are an alternative for people with a small amount of capital or those who wish to pool their risk in the bond market with other investors. A bond mutual fund uses the money it receives from investors to buy different bonds from different bond issuers, which also limits the risk and cost involved in buying individual bonds. Investors in a bond fund receive an ownership stake in the fund based on the amount of their investment.
Other People Are Reading
Instructions
-
-
1
Look at the credit rating of the bond fund. Typically, AAA is the best and D is the worst. Bond funds with higher credit quality have lower risk, but also lower yields. Bond funds with lower credit quality have higher risk and offer higher returns because of the higher risk to which investors are exposed.
-
2
Look at the average length of time the bonds in the bond fund will be maturing. The maturity terms are classified as: short-term, intermediate term and long-term. Bond funds with longer maturities pose greater risks because of the potential for interest rate increases during the life of the bonds, which decrease the value of the bonds. However, bond funds with longer maturities pay higher returns because of the increased risk.
-
-
3
Compare the minimum amount of investment that the bond funds will allow and the cost of each share in the fund. For investors who do not have much investment capital, bond mutual funds give them a way to own shares of a diversified bond portfolio as opposed to coming up with about $100,000 to buy a diversified individual bond portfolio.
-
1
Tips & Warnings
Shares of bond funds are easier to sell than individual bonds, which are often far less liquid.
Bond funds never mature. When individual bonds in the fund mature they are replaced by newer bonds so there is always the risk of selling a bond fund for less than you paid for it. The fund's selling off of aging bonds and buying of newer ones could create taxable capital gains for the fund's shareholders.
References
Resources
- Photo Credit savings bonds image by Stephen VanHorn from Fotolia.com
