How to Evaluate Bond Funds

Not all mutual funds that specialize in bond investments are the same, so it pays to approach investing in a bond fund the same way you do research on stock investments. The primary difference in bond mutual funds, aside from their portfolios, is the cost of buying into the fund and the annual fees charged. The "load" on a fund is the transaction cost of buying. Some funds are no-load, which might come with a required length of time you must hold the fund. Others have graduated loads depending on the class of shares you buy. Fees are annual charges that cover the fund's administration expenses and can be higher than the fund's rate of return, meaning you lose money by holding the fund and paying the fees.

Step 1

Check market yields for corporate bonds, municipal bonds and U.S. Treasury bonds of short (two to five years), intermediate (five to 10 years) and long maturities (10 years and longer). This will give you an idea of the level of return to expect from a well-managed, high-quality bond fund. Higher yields might indicate the fund is invested in junk bonds, which are somewhat risky investments.

Step 2

Check the types of bonds in the fund. There are three kinds of bonds: corporate, municipal and Treasury. The interest on municipal bonds is lower because it is not taxed by the federal government and may not be taxed by your state and local governments. Treasury bond interest is normally not taxed by your state, while corporate bonds are fully taxable.

Step 3

Check the average maturity. The longer the maturity, the higher the market and interest rate risk. Longer maturities experience larger price drops than shorter maturities per a given rise in market interest rates. Because of this, longer maturities pay higher interest.

Step 4

Check the average credit quality. If your risk tolerance is low, choose funds that contain bonds with credit ratings no lower than Baa/BBB. The highest credit quality is Aaa/AAA. The bond fund itself also has a credit quality rating.

Step 5

Compare the fund's returns with the current market yield. Bond funds returning significantly higher yields than can be found in the open market might contain low credit rated junk bonds and could be considered risky investments.

Step 6

Consider the fund's historical returns over the past decade or since inception. Look for figures on rate of return, not yield. The rate of return is the return on your investment. High fees and poor portfolio management may negatively affect the rate of return even though the average yield is good.

Tip

  • Morningstar is a mutual fund research and rating firm where you can find information on most mutual funds. The major online brokerage firms also have extensive information on the mutual funds they offer. These services are a good way to research funds you are considering.

Warning

  • Transaction costs to buy a fund and the fund's own internal fees affect the rate of return you will receive on your investment. Fees and expenses are listed in the mutual fund's prospectus, so compare the costs associated with buying and owning the fund before you purchase.

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