Faith Morrow
Bond funds are a type of investment fund that holds fixed-income securities, such as government and corporate bonds, instead of stocks. They are similar to stock funds in that they invest in a diverse range of investments but differ in that they aim to provide income rather than long-term growth. Bond funds can be a good way to add stability and reduce risk in a well-balanced portfolio. They can also help investors keep pace with inflation, especially when investing in government bonds, which are routinely adjusted for inflation. When deciding which bond fund to invest in, it is important to consider factors such as the fund's expense ratio, credit quality, and average maturity.
| Characteristics | Values |
|---|---|
| Investment type | Fixed-income securities |
| Investment options | Government bonds, corporate bonds, securitized debt, mortgage-backed securities, asset-backed securities, investment-grade debt, high-yield debt, international bonds, etc. |
| Risk | Less risky than stocks, but still subject to interest rate risk and credit risk |
| Returns | Income generated through interest payments |
| Tax | Tax-exempt or taxable, depending on the fund and investor's tax bracket |
| Maturity | Short-term, intermediate-term, long-term |
| Credit quality | Investment-grade, high-yield ("junk"), Treasury, etc. |
| Inflation protection | Inflation-protected bond funds are available |
What You'll Learn
Government-bond funds
Long-term bond funds, as the name suggests, invest in bonds with maturities of more than 10 years. These funds are more sensitive to interest rate changes and are characterised by higher levels of risk and potential volatility. They are typically chosen by investors with a long-term investment horizon who can tolerate the associated risks.
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Corporate-bond funds
These funds are a popular way for businesses to raise money as the associated costs are lower than bank loans. Businesses may sell corporate bonds to fund short-term expenses such as working capital, advertising, and insurance premium payments.
Some examples of corporate-bond funds include:
- IShares 5-10 Year invmt Grd Corp Bd ETF
- IShares Broad USD Invm Grd Corp Bd ETF
- SPDR® Portfolio Interm Term Corp Bd ETF
- IShares ESG USD Corporate Bond ETF
- Vanguard Interm-Term Corp Bd ETF
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High-yield bond funds
Despite the risks, high-yield bond funds offer potential for higher returns. Companies issuing these bonds have the potential to turn their financial standing around, creating opportunities for investors to realise capital gains as bond values increase due to improving business conditions or improved credit ratings.
Some examples of high-yield bond funds include:
- SPDR Bloomberg High Yield Bond ETF (JNK)
- IShares BB Rated Corporate Bond ETF
- Xtrackers USD High Yield Corp Bd ETF
- Vanguard High-Yield Tax-Exempt
- BlackRock High Yield Bond
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Municipal-bond funds
By purchasing municipal bonds, investors are essentially lending money to the bond issuer in exchange for regular interest payments, typically semi-annually, and the return of the original investment, known as the "principal", upon maturity. The maturity date of a municipal bond is the date when the issuer of the bond repays the principal, which may be years in the future. Short-term bonds mature in one to three years, while long-term bonds mature after more than a decade.
The interest generated by municipal bonds is generally exempt from federal income tax. Additionally, if the investor resides in the state where the bond is issued, the interest may also be exempt from state and local taxes. Due to the tax advantages, municipal bonds usually offer lower interest rates than taxable fixed-income securities with similar characteristics. Municipal bonds are considered low-risk investments, and issuers are highly likely to repay their debts. However, it is important to note that investing in municipal bonds, like any other investment, carries certain risks, including call risk, credit risk, interest rate risk, inflation risk, and liquidity risk.
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Inflation-protected bond funds
The value of investments in these funds can increase or decrease in response to economic and financial events, and there is a risk of losing money in these funds. Additionally, loans that these funds invest in are traded in a private, unregulated market, which may impede the fund's ability to buy or sell them.
- SPDR Portfolio TIPS ETF
- IShares TIPS Bond ETF
- Schwab US TIPS ETF
- PIMCO 15+ Year US TIPS ETF
- Simplify Interest Rate Hedge ETF
- Global X Interest Rate Volatility and Inflation Hedge ETF
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Frequently asked questions
Bond funds are similar to stock funds as they invest in a diverse range of investments, but they hold fixed-income securities instead of stocks.
Bond funds offer higher income potential and can add stability to your portfolio. They can also help reduce investment risk as they can contain hundreds, sometimes thousands, of bonds in a single fund.
Bond funds can invest in government, corporate, securitized, and mortgage-backed debt. They can also invest in international bonds, which can add another level of diversification to a portfolio.
There are domestic bond funds, flexible bond funds, government bond funds, corporate-credit funds, and world and emerging markets bond funds.
When choosing a bond fund, consider your tax bracket, whether you want domestic or international bonds, and your risk tolerance. Also, look at the average maturity and credit quality of the bonds within the fund.
