When to Buy Bond Mutual Funds?
Companies and governments borrow money by issuing bonds. The interest rates and durations of bonds vary depending on the credit strength of the issuer and the prevailing interest rates at the time of issuance. Due to the wide variety of bonds and mutual funds that contain bonds, there are many occasions when it makes sense to invest your money in certain types of bond funds.
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Downturn
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If you hold a bond until it reaches maturity then you receive back your original investment, unless the issuer goes bankrupt. When you buy a stock you become a part owner of the company and even if the company remains solvent you could lose money if the stock loses value. Consequently, most types of bond funds are much less volatile than stock funds. During a market downturn you can normally move money from a stock fund to a bond fund operated by the same mutual fund company without having to pay any sales charges. You can keep your money in the bond fund until you feel comfortable moving your money back to stock funds. However, some bond funds that contain subprime mortgages or low-rated bonds are as volatile as stock funds. So only use government bond funds or conservative mortgage or corporate bond funds as a safe-harbor investment.
Interest Rates
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When interest rates are low, the rates paid on bank instruments are minimal, which can cause people who rely on interest income to experience a drop in income. When this occurs you can move your money to bond funds to get a higher yield. Bond funds are not federally insured so investors are rewarded for taking a degree of risk with higher yields than you can get on federally insured accounts. However, do not commit too much money to funds that contain long-term bonds as inflation may erode the returns on these funds over the course of many years.
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Taxes
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You have to pay income tax on most types of investment earnings, and when taxes are rising this can significantly reduce your net income. The federal government exempts interest payments from most types of municipal bonds from income tax. Additionally, you do not normally have to pay taxes on interest payments on bonds issued by the state where you live or local governments within that state. Therefore, you should think about buying bond funds when taxes look set to rise or when you are attempting to cut your tax burden.
Supply and Demand
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Bond markets, like the markets for all goods and commodities, are driven by supply and demand. When large numbers of companies and governments issue bonds at the same time, the supply outweighs the demand and this drives down bond prices. This hurts people who currently hold bond funds but presents an opportunity for others to buy into the bond market at a discount price. As bonds near maturity, bond prices return to par value. Therefore, you can make a healthy profit if you buy a fund for below par value. However, like all securities, bond funds expose you to risks, including loss of principal, so speak to an investment adviser before making your investment selection.
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References
- "USA Today"; There's Never a Bad Time to Buy a Bond Fund; Matt Kranzt; January 2009
- "Bloomberg Businessweek"; Bonds: Is Now the Time to Buy Long-Term Munis?; August 2009
- "Kiplinger"; It's Time to Buy Bonds; Jeffrey Kosnett; October 2008
- CNNMoney; Muni Bonds Headed for Worst Quarter in 10 Years; Blake Ellis; March 2011
