Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Bond Fund

What it is:

A bond fund is a mutual fund or exchange traded fund (ETF) composed of bonds.

How it works (Example):

Bond funds come in many shapes and sizes. Some of the major bond-fund categories are:

  • U.S. Treasury bond funds
  • Municipal bond funds
  • Mortgage-backed security funds
  • Corporate bond funds (within this category are several subcategories based on target maturities, credit rating, industry, etc.)
  • International bond funds
  • Mixed (where the fund manager invests in a variety of different bond categories)

It's important to note that bond funds are composed of bonds, but they don't always behave like bonds.

For example, bond funds do not mature like individual bonds do. Instead, fund managers buy and sell bonds of differing maturities, which produces constantly changing trading profits, losses, and yields. Although a bond fund's investments do mature, the fund's investors typically don't get their original investments back until they sell their shares (and even then there is no guarantee the fund's share price won't be below the investor's purchase price).

Most investors agree that it is usually easier and less expensive to invest in bond funds than to choose each and every bond in a portfolio. And in addition to the convenience of monthly payments, a bond fund's instant diversification often means lower risk. Bond funds also are a way to avoid the often higher transaction costs and lower liquidity associated with trading individual bonds -- it's often easier to sell bond fund shares than to sell a particular bond, especially if that bond has unusual characteristics or a low credit rating.

Why it Matters:

Bond funds offer many tailored choices that go way beyond simple time horizon. For example, target maturity funds are great for investors who need a certain amount of money for a specific purpose at a specific point in the future (such as college tuition). Municipal bond funds can be helpful income investments for investors in especially high tax brackets. International bond funds offer more return and risk potential from their investments in bonds issued by foreign governments or foreign companies in a variety of markets, industries, and currencies.

Even higher on the risk spectrum are high-yield bond funds, which invest in corporate bonds rated below BBB and tend to be more sensitive to changes in their issuers' financial outlooks than to changes in interest rates (they subsequently can actually offer investors a hedge against interest rate risk).

Related Terms View All
  • Auction Market
    Though most of the trading is done via computer, auction markets can also be operated via...
  • Best Execution
    Let's assume you place an order to buy 100 shares of Company XYZ stock. The current quote...
  • Book-Entry Savings Bond
    Savings bonds are bonds issued by the U.S. government at face values ranging from $50 to...
  • Break-Even Point
    The basic idea behind break-even point is to calculate the point at which revenues begin...
  • Calendar Year
    If Company XYZ starts its fiscal year on January 1 and ends its fiscal year on December...