| Investing in bonds by owning a bond fund is easy | | | | bond until 2039. You can sell it at will on the bond |
| compared to selecting individual bonds. Few | | | | market, or buy more bonds at market price if |
| average investors can analyze bonds, so the vast | | | | you wish. But beware that bond prices fluctuate, |
| majority investing in bonds buy a mutual fund | | | | as do stock prices. Bond prices or values can go |
| called a bond fund, and let professional money | | | | up and they can go down. In other word, a $1000 |
| managers make the selections for them. Hence, | | | | bond is not necessarily worth $1000 after it is |
| when you own a bond fund you own part of a | | | | issued. Hence,there is market risk involved when |
| professionally managed portfolio of bonds, often | | | | investing in bonds. |
| called an income fund. | | | | Now picture an income fund invested in a portfolio |
| Don't get confused. Investing in bonds or an | | | | of bonds similar to ABC bonds. Because this bond |
| income fund has little in common with buying U.S. | | | | fund holds a wide variety of different bonds, |
| Savings Bonds. The government guarantees that | | | | investors need not worry about a company like |
| you will not lose money in savings bonds. There is | | | | ABC going broke and not making interest |
| no market risk in these savings products. When | | | | payments or not paying investors back upon |
| investors speak of bonds they are not referring | | | | maturity. The fund is broadly diversified. |
| to savings bonds. | | | | The real risk you should be aware of when |
| A bond fund is sometimes labeled as an income | | | | investing in bonds and bond funds is of a different |
| fund, because the primary objective is to provide | | | | nature, and this risk is called interest rate risk. |
| higher income vs. other investments. These funds | | | | Interest rates in the economy fluctuate, but a |
| pay dividends from the interest earned on the | | | | bond's coupon rate does not. ABC bonds, for |
| bonds in the fund portfolio. Along with this higher | | | | example, pay $60 per year, period. |
| income, investing in bonds involves risk. Bond | | | | What happens when long term interest rates in |
| prices or values fluctuate because bonds are | | | | the economy go up? Simply this: the value of |
| marketable securities that trade in the open | | | | existing bonds, in other words bond prices, go |
| market, much like stocks do. | | | | down. |
| In order to understand investing in bond funds, | | | | Look at it this way. If interest rates double and |
| you first need to learn some bond basics. Let us | | | | go from 6% to 12%, new bonds will be paying |
| turn our attention now to a simplified bond | | | | investors $120 per year in interest vs. $60. What |
| example, a new issue of a very basic corporate | | | | do you think investors in the bond market would |
| bond. | | | | be willing to pay for a 6% bond under these |
| ABC Corporation decides to raise a large sum of | | | | circumstances? Since investors buy bonds for the |
| money to expand their operations. Instead of | | | | higher interest they offer, the price of our 6% |
| selling stock to the public, they decide to sell | | | | bond will fall like a rock. The bond price will not |
| bonds. In other words, they will borrow money | | | | likely fall in half, but it will be heading in that |
| from investors. Each bond has a face value or | | | | direction. |
| initial bond price of $1000. The coupon rate will be | | | | Interest rates peaked in 1981-82, and have |
| 6%. These are high quality bonds and mature in | | | | generally been falling since. Contrary to our above |
| 2039. Once all of the bonds are sold ABC gets | | | | example, falling interest rates send bond prices |
| their money, and these bonds begin to trade in | | | | higher. Investors in bonds and bond funds get |
| the bond market. | | | | income from interest or dividends when interest |
| If you buy an ABC bond for $1000, ABC | | | | rates fall, plus the value of their investment |
| promises to pay you $60 per year, or 6%, for as | | | | increases. |
| long as you own it until 2039 when the bond | | | | But interest rates can not fall forever. When they |
| matures. At that time the bond owner gets the | | | | do head north again many folks invested in bond |
| $1000 back, and the bond no longer exits. Up until | | | | funds or income funds will be caught standing flat |
| that time the deal never changes. ABC promises | | | | footed. Invest informed and understand this: |
| to pay the bond owner $60 per year, period. | | | | When interest rates go up significantly, the value |
| You as a bond holder are not required to hold the | | | | of your bond investments will fall. |