June 14, 2010
We have covered different types of bonds in Parts One and Two of this series. Today let's talk about bond mutual funds. Most people know the general description of a mutual fund: a diversified pool of investments, typically professionally managed, in which you can buy shares. When you own a fund that invests mainly in stocks, your fund will tend to perform like the stock market. Profitable well-managed companies will generally see their stock price rise over time, but in the short run any stock will fluctuate, and mutual funds that own stocks will act the same. Many investors consider bond funds as a simple and safe way to invest in bonds. But bond funds do not have a tight relationship with how individual bonds work.
Most bond funds pay out their cash earnings either monthly or quarterly. That is a convenience for fund owners as individual bonds typically pay interest every six months. So if you want a regular income stream, a fund can get that job done. But this post is about safety. Safety of income and safety of your principal are stronger in a bond than in a fund. Why? A bond is a contract with a well-defined interest rate and a specific maturity date. In other words, you know what you will get and when you will get it. A fund will pay out a varying stream of income dependent on what it earns, and there is no fixed maturity date. In short: a bond fund will pay out steady income, but you cannot be sure that it will pay the same income year over year. And a bond fund will tend to have a fairly steady share price, but you cannot count on getting you original investment back, even if the fund invests in high quality bonds.
Next: How Safe is Gold?
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).