Investing in Bond Mutual Funds | Home Finance Help

Bond mutual funds are an easy and cost-effective way to diversify your portfolio.

Just like a mutual fund invested in stocks, a bond fund is compiled of a large amount of individual bonds.

Each bond inside of the fund has it?s own risk, interest payment, and maturity date. At the end of each month you receive the commutative interest payments from the bonds you held that made a payment during that month.

Investing in a bond mutual fund is a lot different then investing in a single bond. A single bond pays a fixed interest rate and has one maturity date. A bond fund is composed of multiple bonds with different maturity dates and interest payments. Once a bond inside of a fund reaches its maturity date, the fund manager buys a new bond to replace the expiring bond.

Advantage of investing in bond funds

• Low minimums ? You wouldn?t have the ability to invest in some bond markets without investing in a bond fund
• Diversification ? Spread risks through multiple types of bonds
• Income ? You will receive monthly income from investing in a bond fund
• Stability ? Investing in a bond fund can stabilize a portfolio that?s heavily investing in stocks
• Liquidity ? Selling or buying a bond fund is a lot easier then a single bond

Types of Bond Mutual Funds

Each category will fill a different objective for the investor. You should be able to tell the fund?s objective through its name. The list below lists the most common types of bond funds. It is possible to have a characteristic from each category. For example, a bond fund made up of Short-Term Taxable Investment Grade Corporate Bonds.

Duration

• Short-Term ? Average maturity date of less then 1 year
• Intermediate Term ? Average maturity date of 1-10 years
• Long-Term ? Average maturity date of 10 years or above

Tax Status

• Taxable ? Bonds in which the interest payments are taxed as income
• Tax-Exempt ? Interest income can potentially be tax-free

Tax Status

• Investment Grade ? Bonds that have a rating of BBB or above
• High-Yield/Junk Bonds ? The fund has a portion in bonds rated below BBB

Issuer

• Corporate ? Issued by a corporation in the U.S. looking for access to cash
• GNMA ? Invests in bonds issued by The Government?s National Mortgage Association
• International ? A company headquartered outside of the U.S.
• State or Local Municipal ? Sells bonds to finance larger expensive projects, like schools and roads
• U.S. Government ? Sells bonds to finance the national debt

Characteristics of a Good Bond Mutual Fund

• Low expense ratio, less then .25%
• No front or back loads
• Detailed prospectus about the fund?s objective
• Experienced professional manager

Investing in Bond Mutual Funds with Tax Efficiency

The structure of any bond, make for a very tax-inefficient investment. If you?re investing for retirement, always place the bonds inside tax-sheltered accounts like an IRA or 401K. This way monthly interest payments will not be taxed as income. Then, for the stock portion of your portfolio, use tax efficient investment principles to help you avoid taxes.

Source: http://www.thehumblemumble.com/investing-in-bond-mutual-funds/

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