Bond Fund, Bond Funds
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A bond fund collects money from several investors and has professional fund managers who invest this money in a range of debt instruments. This may include corporate bonds, municipal bonds, convertible bonds and a plethora of other financial instruments.
Table of Contents
Yield on Bond Funds
A bond fund typically pays periodic dividends, including interest payments and capital appreciation. Usually bond funds pay higher dividends than CDs and money market accounts.
The calculation of yield depends on the selection of debt instruments. For example, corporate bonds may involve monthly payments, while in case of treasury bonds, strips and municipal bonds, returns are remitted on maturity, which could range from six months to 40 years.
The most commonly used measure is the 30-day annualized yield, which takes the yields of all the bonds in the bond fund and averages it over the past 30 days. However, this figure does not indicate the fund’s future yield. It does help in comparing bond funds from different companies.
Benefits of Bond Funds
Bond funds offer certain benefits vis-Ã -vis individual bonds. These can be seen against the following parameters:
Professional Management
- Time tested expertise and detailed security analysis by fund managers.
- Relief from comparing maturity period, tax benefits and issuer creditworthiness.
Diversification
- Investment in a variety of bonds delivers better results.
Liquidity and Convenience
- Freedom to reinvest income dividends and undertake additional investments.
- The initial amount of investment is relatively low.
- Exemption from tax burden via municipal bonds.
- Secured returns by treasury securities.
Drawbacks of Bond Funds
While opting for bond funds, an investor must be careful of the following:
- Volatile return: An increase in interest rates reduces bond prices. There may be monthly variations in returns. A longer maturity period leads to a higher element of risk.
- Credit risk: This refers to the risk of default when the issuing authority is unable to generate income.
- Fluctuations: The value of a fund share (also known as the share price or net asset value) may fluctuate on a daily basis.
- Call risk: Corporate bond issuers often declare the redemption of bonds. In doing so, they are obliged to pay only thepar value to an investor.