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Also, what is your opinion on the strategy to exit bond funds in uncertain times like we are living in? I know interest rates are the key, but I think I should stay in bond funds until feds raise the rates.
Paul 1:04 am on July 13, 2010
You can think of a bond fund as holding a portfolio of bonds with no maturity date. In effect, that is basically the case, from the standpoint of the fund shareholder.
The fund manager is going to buy and sell bonds in his portfolio to maintain the objective of the fund. If the fund is a high yield fund, he is only going to purchase bonds that pay a coupon rate above a given threshold. If it is a long term Treasury bond fund, he is only going to buy Treasuries with maturities longer than a specific time frame.
When you hold individual bonds, you know the coupon rates, your yield (because you know what you paid for them) and the maturities. Those three thing don’t change until a bond matures or you act by making a sale or by purchasing other bonds. Those three things change all the time with a bond mutual fund because bonds held by the fund mature on a regular basis or are sold and replaced with others purchased by the fund manager. That is why the yield and the interest distribution amount changes month to month. The amount of interest payments received by the fund and then distributed to shareholders changes constantly because of the varying coupon rates and payment schedules of the paper held by the fund.
The general rule of bond prices falling when interest rates rise and vice versa applies to bond funds as well. If you wait too long in an environment where rates will rise, the share price of your bond fund can fall pretty quickly. If you purchase a bond fund strictly for the income stream, this isn’t a concern, but a drop in the share price of a portion of your portfolio is always significant and since most bond funds have fairly low share prices, it doesn’t take a large move dollar wise to have an impact.
Pierre O 1:04 am on July 13, 2010
It is similar to Mutual Funds and Stocks.
A bond fund allows you to hold several bonds with a small amount of investment. It provides diversification of your risks so that even if one company goes bankrupt, you only lose a portion of your investment.
Cosmetology Center 5:14 am on July 13, 2010
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