Bond Mutual Funds And Fixed Income

Bond mutual funds are those that invest in bonds and other kinds of debt securities. Such investments are more on the conservative side, in a sense that they have a lower risk and protect the capital invested, and pay a regular income. Bond funds usually give out monthly dividends that will include interest paid on the fund’s underlying securities, as well as capital appreciation, if any, on the prices of the bonds in the investor’s portfolio. A bond price will also have a NAV (Net Asset Value), which is the price at which the shares in the fund are traded.

Investments in bond funds serves two purpose for an investor- while they pay out regular income, they also helps in diversifying the investment portfolio, offsetting risks that might be faced with other form of investments. Bond funds usually pay higher dividends than money markets, and savings accounts, and these also pay dividends more frequently (monthly), as compared to individual bonds. While bond funds are considerably “low risk” investments, however, these are still not completely risk free. Bond mutual funds carry same interest rate risk, and credit risk as regular bonds. But as bond mutual funds spread out their investments over many bonds, the risk factors usually comes down. Bond shares can be sold and bought more easily, and thus such investments are more liquid in nature. Many bonds are exempt form federal and state taxes.

Bond funds are of three basic types- US government bond funds, municipal bond funds, and corporate bond funds. Various types of bonds offer different returns in line with the amount of risk in each fund.

US Bond Funds These are the funds that invest in debt securities issued by the United State federal government, and its various agencies. As the underlying securities are backed by faith and credit of the United States government, these are regarded as the safest of the various bond funds. These funds usually invest in debt instruments issued by the government, like Treasury Notes, Treasury bills, Treasury bonds, and mortgage backed securities. Certain funds like the Treasury funds are exempt from state and local taxes. The only risks involved in such investments arise from fluctuating interest rates, and inflation.

Municipal Bond funds These funds invest in debt securities issued by local governments, which are used to pay for public projects like highways, bridges, and schools. These bond funds are exempt from federal taxes, as well as state taxes in some cases, and thus are very famous with high-income investors. As the government backs the underlying securities, they have a high credit rating. Municipalities are however, known to declare bankruptcy, and thus they have certain risks.

Corporate Bond Funds These funds invest in bonds issued by private corporations, and are not backed by any government institutions. Thus, if the company issuing the bonds runs into financial trouble, the bonds could default. But the income paid out by such bonds is more than that paid by government issued bonds, and thus it gives you more returns for increased risks.