The category of bond funds covers a large range of investment choices. The yield a bond fund pays depends on the types of bond the fund owns and the current interest rate environment. Published yield data from individual bond funds give you an estimate of how much income a fund will pay.
Types of Bonds and Funds
The characteristics of a bond fund are determined by the types of bonds it owns and how the bond portfolio is managed. Types of bonds include government, foreign, corporate and municipal bonds. A fund may own lower rated, riskier bonds for a higher yield or go for safety with high quality or government bonds. A fund also manages its yield and volatility by buying bonds of different maturities. Longer-term bonds pay higher yields in exchange for greater price fluctuations. The published investment objectives and overview of a bond fund will tell you where in the bond market that fund invests.
Bond Fund Yields
A bond fund pays out the interest earned from the fund's portfolio to investors in the form of monthly dividends. The current yield of a fund is the monthly distribution amount annualized and divided into the fund share price. For example, if a fund is paying a 5 cent dividend every month and the share price is $10, the current yield is 6 percent. Bond funds also publish what is called the 30-day SEC yield. This is a more complicated calculation mandated by the Securities and Exchange Commission. The SEC yield is the rate a fund investor would earn over the next year if the holdings of the fund did not change.
Total Return vs. Dividend Earnings
Bond funds also quote total return results. Bonds are marketable securities, and bond price changes will result in bond fund share price changes. The total return an investor earns is the combination of share price change and dividends paid. Bond prices change primarily due to changing interest rates. Because future rates are impossible to predict, the future return of a bond fund cannot be accurately predicted.
Dividend Reinvestment vs. Cash
If you are investing in a bond fund to earn spending money, the amount and stability of the dividend determines how much income you will earn. If a fund pays a steady dividend rate, you can expect a relatively level monthly dividend check. The dividend will change over time if rates move up or down significantly. Check the dividend history of a fund to determine if it pays steady or fluctuating dividends. With mutual funds -- but not exchange traded funds or closed-end funds -- you can choose to have your dividends reinvested into more fund shares. In this case, you are more concerned with the total return of the fund as your share balance grows with the reinvested dividends.
Video of the Day
- Creatas Images/Creatas/Getty Images