Bond funds are mutual funds that invest your money primarily in a variety of bond assets. Bonds funds are similar to other types of mutual funds, allowing you to easily diversify your investment holdings. Although bond funds offer many benefits, they also come with problems that affect investors. Understanding the characteristics of a bond fund can help you easily identify its benefits and risks. You can then make an informed investment decision of whether bonds funds are right for your portfolio.
Similar to other types of mutual funds, you must pay fees when investing in bond funds. The fees associated with bond funds are assessed to investors to cover operating costs and manager commissions. The problem is that fund fees can significantly diminish your returns. You are required to pay fees whether the bond fund realizes positive or negative returns. The fees associated with a bond fund are explained in the prospectus. It is important to understand a fund’s expenses and how they might impact your return.
Bond funds are actively-managed assets. The bonds selected for the fund are chosen by the asset manager. This can lead to a problem, especially if the manager is not choosing investments that offer attractive returns. You also do not choose the interest rate you receive from investing in bonds, which is significant because it affects the amount of your interest payments. If the bond fund manager sells some of the bonds for a profit, you may also need to pay tax on the gain.
In contrast to individual bonds, the risk associated with a bond fund can fluctuate because the underlying assets change as the fund manager sees fit. At any given time, the fund might invest in bonds you consider too conservative or too risky. For example, if the fund manager begins focusing more on buying long-term bonds, the portfolio will experience increased exposure to interest rate risk. The terms of a bond vary per issuer, so interest payment amounts on a bond fund can also change as assets are bought and sold.
No Maturity Date
Bonds are considered long-term investments. Most investors purchase bonds with the desire to hold them until maturity. When you invest in bonds, the issuing company agrees to return your principal when the bonds mature. This is not a feature associated with bond funds. Managers make trading decisions constantly, so often bonds are sold before they reach maturity. You do not receive the initial investment back that you made when you started the bond fund.