Bonds and Money Markets
Investment advisors and advertisements on television might talk about how bonds are a safe place for long-term investment, but it's very important for investors to be aware of their risks. Bonds are debt securities, or investments in loans made to organizations like the government or corporations. Even inexperienced investors know that not everyone pays back their loans, which means that money invested in bonds can be lost. To be an informed investor and help protect yourself against some of these risks, it's important to know the difference between some popular types of bond funds.
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Basics
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Bonds are a common form of long- and medium-term investment. Bonds are generally considered to be a conservative investment option, though they are not without market risk. Bonds consist of debt securities, and those who invest in them are essentially lending money to an entity, usually a government or corporation. Bonds pay investors regular interest during the term of the bond, and repay the bond's value completely at the end of the term. The end of a bond's investment term is called "maturity." Bonds also have market value -- they can be bought and sold by investors during the life of the bond.
Bond Funds
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Bond funds are mutual investment funds that consolidate several bond investments. In contrast to purchasing a single bond, a bond fund consists of multiple securities and may invest in a variety of debt-issuing organizations. Bond funds are designed to help diffuse the risk associated with a single bond, though bond funds also have their own investment risks. Bond funds can lose value if interest rates drop, if issuers decide to pay down bonds early or if issuers default on their debts.
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Money Market Funds
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Money market funds are similar to bond funds in that they invest in multiple securities, and that they invest in credit obligations. As with bond funds, investors in the money market are generally lending money to bond issuers like corporations. The primary difference between money market funds and bond funds is the length of time to maturity. The debts in money market funds mature much more quickly -- on average, in no more than 90 days. Money market funds are also highly liquid, meaning that they can easily be converted for cash. Because of this and their shorter maturity, they usually offer lower interest and less risk than bond fund investments.
Ultra-Short Bond Funds
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Another mutual fund option for investing in bonds are ultra-short bond funds. Ultra-short bond funds are often thought of as similar to money market funds because they invest in bonds with very short maturities. But there is an important difference between ultra-short bond funds and the money market: exposure to risk. Ultra-short bond funds are not regulated in the same way as money market funds, which are required to invest primarily in low-risk securities. As a result, ultra-short bond funds can often achieve higher yields than money market funds, but carry with them significantly more risk of loss.
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References
- U.S. Securities Exchange Commission: Bonds; Modified June 2008
- U.S. Securities Exchange Commission: Bond Funds and Income Funds; Modified March 2010
- FINRA: Money Market Securities and More
- Investment Company Institute: Frequently Asked Questions About Money Market Funds; January 2011
- U.S. Securities Exchange Commission: Ultra-Short Bond Funds...; Modified May 2009
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