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Bond Funds, Fun
Bonds aren't the easiest instrument to understand or trade.
They have more predictable characteristics — owing to their
fixed maturity (principal repayment date) and coupon (interest
rate). But those predictions are fairly technical and sometimes
even difficult to follow for the beginner.
Bonds also traditionally have higher investment capital
requirements. They're usually issued in $1000 increments, with
a $5000 minimum investment requirement commonplace.
But, part of the fun of investing is overthrowing tradition.
Meet Bond funds.
Like other funds, bond (fixed-income) funds operate by pooling
investor money then diversifying that investment by buying and
selling different instruments, attempting to maximize return
while minimizing risk.
Since the fund is managed by investment professionals, so the
theory goes, it has a better chance of achieving those goals
than individual investors with limited time and training at
picking specific bonds.
For that service, of course, the investor (usually) pays a fee.
Different funds have differing payment options — front-end
loads (which charge a commission when shares are purchased),
back-end loads (which charge when selling out, but often carry
an annual fee as well), and no-loads (no commission).
Opinions differ over the pros and cons of the commission
options, but a comment or two here will suffice. No-load funds
carry no commission because the shares are offered directly by
an investment company. Therefore, no adviser continually
monitors the investment. Whether the adviser's fee is more than
made up for by the added advice is a matter of some
controversy. But then, in investing, what isn't?
The investors are said to be 'buying shares' because,
legally/technically, most funds operate by offering shares in
the fund company (also called 'the fund'), which then uses the
money to buy the instruments making up 'the fund' (the basket
of instruments in the portfolio). Confusing enough?
The downside of fund investing isn't just the management fees
paid, however. Unlike the bonds they buy, the investment isn't
guaranteed. Granted, no bond is truly guaranteed, but highly
rated corporates (AA or above) or U.S. Treasuries are about as
good a guarantee as one gets in life.
With a fund, the risk is on the investor that the fund may make
money or lose money. And, according to some, nine out of ten
fund managers lose money for their clients. But, ah, that
tenth!
There are, even so, several advantages to fund investing.
As stated, most investors don't have the time or expertise to
carefully research or track individual bonds.
Not surprisingly, there exists a bewildering variety of bond
funds — those that focus on primarily governments (of which the
U.S. Treasury alone has over 30 choices), corporates
(thousands), foreign, asset-backed and dozens other categories
or mixtures thereof.
That problem can be solved by investing in well-known, low-risk
bonds, but they carry a correspondingly low yield (return over
time).
For those willing to endure more risk, there are still
advantages. Bond fund managers use an array of hedging
techniques — including buying indexed funds, such as those that
adjust automatically for inflation or fluctuate according to
bond indexes.
They're also paid to be aware of any new instruments offered
and trade without charging individual trading fees for getting
in and out. Those trading fees, even at $10 a pop can add up to
an annual management fee pretty quickly for investors who trade
often. Funds allow investors to input lower amounts, often much
lower than is required to purchase the underlying bonds. Now
for the kicker. One of those types of funds, requires the
investor to input as little as $25.
MBSs (Mortgage-Backed Securities, once esoteric, now common)
FITRs (Fixed-Income Exchange Traded Funds, recently the latest
rage, now becoming common) and even more creative methods of
packaging debt for investors come and go with blinding
speed.
A good fund manager will know how to take advantage of those
complex and beautiful creatures. If you can find that tenth
one.
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