| Investors are pouring billions into bonds by way of | | | | individual bond you know exactly what you will |
| bond funds to earn higher interest rates. Bond | | | | make each year in interest; and you know that |
| funds are an investor favorite because they offer | | | | when your bond matures you will get your |
| the average investor advantages vs. buying | | | | principal back (unless the issuer defaults). For |
| individual bond issues. But these funds have their | | | | example, if you buy a $1000 bond with a 6% |
| disadvantages as well. Let's look at bond funds vs. | | | | coupon rate that matures in ten years: you will |
| bonds. | | | | earn $60 a year in interest and get $1000 back in |
| Millions of everyday people own bond funds | | | | ten years. |
| because they are easy to invest in and they pay | | | | Bond funds do not mature. On an ongoing basis |
| higher interest or dividends then they can get at | | | | they take in money from investors, redeem |
| the bank. When you invest money in a bond fund | | | | shares for existing investors, and buy and sell |
| you own part of a professionally managed | | | | bonds in their portfolio. Let's look at a possible |
| portfolio of these securities. That diversification | | | | scenario most bond investors would rather not |
| decreases your credit risk or risk of default | | | | think about. |
| because your money is spread around. | | | | You invest in a bond fund with an average |
| In fact, without bond funds many average | | | | maturity of 10 years when interest rates are real |
| investors would probably not invest in bonds. First, | | | | low, and 10-year bonds of the highest quality are |
| these funds are often SOLD to investors looking | | | | yielding about 4% or so. You elect to have your |
| for higher income by financial planners and other | | | | interest in the form of dividends sent to you as |
| investment representatives. Second, most people | | | | income. Interest rates then go up, as bond prices |
| are intimidated by the prospect of selecting and | | | | fall (as would be the case). Rates continue to go |
| investing in individual bond issues. Bond features | | | | up and the highest quality 10-year bonds are now |
| can be difficult to understand. Why take the risk | | | | yielding 8% six or seven years later. The value of |
| of making a mistake and picking a loser? | | | | your bond fund is down considerably. |
| The most obvious disadvantage of bond funds is | | | | Had you invested in 10-year individual $1000 bonds |
| that many of them sold to investors have a sales | | | | instead of a fund, your investment would have |
| charge and relatively high yearly expenses. It | | | | dropped in value as well... with one difference. |
| doesn't make sense to pay 4% off the top and | | | | After six or seven years you would have |
| more than 1% a year for expenses. Individual | | | | something to look forward to. The value of your |
| bonds can be purchased much cheaper. For the | | | | bonds would eventually rise to $1000 as their |
| average investor funds make sense IF they are | | | | maturity date drew near... no matter what |
| no-load funds (no sales charges) with low yearly | | | | happens to interest rates. |
| expenses of ½% or less. | | | | As a holder of a bond fund in the above scenario |
| There's one more disadvantage to bond funds vs. | | | | there is no maturity date to look forward to that |
| bonds you rarely hear about. When you hold an | | | | can bail you out without a loss of principal. |