One of the major benefits of stashing some of your retirement money in an individual retirement account is the ability to grow your investments on a tax-deferred basis. You get this tax-deferred growth whether you invest in a traditional IRA or a Roth IRA, and regardless of what type of investment you hold in your IRA. Not all investments are suitable for all investors, but bond funds are a good choice for some IRAs.
A bond fund is a mutual fund that invests primarily in debt securities. While these debt securities likely will be government, municipal or corporate bonds, the fund's manager might not be limited to such securities. Depending on the bond fund's investment objective, it might also hold short-term commercial paper, mortgage-backed securities, preferred stock and other debt instruments. Bond funds, like any other security, involve risk. Some funds involve more risk than others and some may be quite risky. Whether a particular bond fund is appropriate for your IRA depends on such factors as your investment temperament and objectives.
Bond funds typically earn the bulk of their growth through collecting interest payments, but they might also reap capital gains from trading bonds. Regardless of how the growth occurs in a bond fund, if you hold the fund in your IRA the growth does not result in a current income tax obligation.
Bond Fund Types
There are bond funds that are designed to appeal to almost every type of investor, and some bond funds that would be perfectly appropriate for your investment portfolio might not be appropriate for your IRA. For example, a municipal bond fund invests primarily in tax-exempt municipal bonds. The tax-exempt feature is attractive to people in high tax brackets, but the interest rate is typically lower than you could get on a comparably rated taxable corporate bond fund. Since the growth on investments in your IRA is tax deferred, the tax-exempt benefit of a municipal bond fund is lost. With a traditional IRA, all of your withdrawals are taxed as ordinary income, so you would have to pay taxes on income that was originally produced tax free.
Approximately 25 percent of the retirement assets in the United State are in IRAs, according to a study conducted by the Employee Benefit Research Institute as reported by U.S. News.com, and 12.3 percent of IRA assets were in bond funds. Conservative bond funds, those that invest only in investment-grade corporate bonds or government securities, are considered less risky than some other types of investments, but they are not without risk. Bond funds, like bonds, are interest-rate sensitive. If prevailing interest rates rise, the market price of bonds and bond funds typically declines.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.