Bond Mutual Funds
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Bond Mutual Funds
Bond funds invest primarily in bonds to provide income with safety of principal. They bring the world of bond investing to the small investor. Most bond funds are conservative, focusing on payment of dividends. That said, investing in bond mutual funds still involves risk, including possible loss of principal. Investors can choose among several types of bond funds. Below are some of the most popular:
Municipal bond funds
Municipal bond funds invest in debts issued by state and local governments. Their dividends may be free from federal taxes.
Government bond funds
Government bond funds invest in debts of the US government and its agencies. These funds include mortgage-backed securities as well as bills, notes, and bonds of the US Treasury.
Corporate bond funds
Corporate bond funds invest in debts issued by companies in the private sector.
Zero coupon bond funds
Zero coupon bond funds are pools of zero coupon bonds. A zero coupon bond is a bond that is sold to an investor at a discount. It does not pay interest. When it matures, the investor receives the face value of the bond. The difference between the face value and the discounted purchase prices is treated as interest.
International bond funds
International bond funds invest in debts of governments and corporations of other nations.
Convertible securities funds
Convertible securities funds invest in debt securities that can be converted into stock. These funds have the objective of current income and growth with preservation of principal. Thus, they offer characteristics of stocks and bonds.
Goals of bond funds
Bond funds generally pay periodic income dividends, which can be taken in cash or reinvested. Their primary goal is current income and preservation of principal, although bond fund prices fluctuate and may result in loss of principal in an unfavorable bond market.
Additional notes about bond mutual funds
Municipal bond funds: Subject to availability and change in price. Municipal bonds in the fund are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income on some private activity bonds may be subject to the alternative minimum tax. Exempt-interest dividends are federally tax-free, but other state and local taxes may apply with special rules often applying to residents buying bonds issued by their own state.
Government bond funds: An investor can lose money when investing in government bond funds. The funds themselves are not guaranteed, and the funds’ performance will vary.
Zero coupon bonds: Zero coupon bonds are subject to large price fluctuations if sold prior to maturity. Investors pay ordinary income tax on zero coupon bonds every year even when no payments have been received.
