Buying Bonds Indirectly

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Buying Bonds Indirectly

Having trouble choosing the right bonds for your portfolio—or coming up with the funds to buy them all? The answer may be one of the indirect ways to invest in the bond market.

Things To Know

  • Both unit investment trusts and mutual funds are indirect ways to invest in bonds.
  • Both of these are ready-made portfolios that you can buy into.

Advantages of unit investment trusts

One option to explore is a unit investment trust, or UIT. A UIT gives you the opportunity to buy a wide variety of bonds in a portfolio that never changes. Some unit investment trusts also specialize in only one type of bond.

The benefit of a UIT is that you know exactly how much you can earn from the trust when the bonds mature. You earn interest during the life of the trust on the amount you initially invest as well as on the trust’s income. UITs are designed so that the bonds in the trust remain fixed with the goal that your initial investment will be completely returned to you when the bonds mature. A trustee supervises the bonds in the trust, but the trustee cannot sell or add new bonds.

Disadvantages of unit investment trusts

Along with the advantages mentioned above, investors should consider the tradeoffs presented by unit investment trusts as well. Common with mutual funds, there will be some form of management fee that will be incurred. Additionally, a UIT may not be as liquid as other investments and if you sell a UIT before it matures, you may receive less than the amount originally invested.

Investors in UITs are taxed on the trust’s income and gains when the trust receives or accrues the income, regardless of whether the trust makes a distribution to the investor, and so UIT investors may have to raise cash to pay this tax if the trust doesn’t make a distribution.

Learn more about the risks of unit investment trusts.

Advantages of bond mutual funds

Another way to invest in bonds is through a bond mutual fund. A bond fund is a portfolio of bonds managed by an investment professional. The big advantage to a bond fund is that your investment buys shares of a managed portfolio of bonds, which helps lower your overall risks. Interest, dividends, and capital gains from a bond fund can be paid or reinvested in the fund. Open-end funds let you buy into or sell out of the fund whenever you wish. Bonds are actively added and sold from the fund by the fund manager. There is no maturity date to a bond fund.

Disadvantages of bond mutual funds

One of the disadvantages of bond mutual funds is that most funds charge a manager’s fee and some charge for buying or selling fund shares. Bond mutual funds are also subject to interest rate and/or credit risk, and you may receive more or less than the amount originally invested.

Learn more about the risks of bond mutual funds.

UITs and bond mutual funds offer the benefits of a bond portfolio and more affordable buy-in costs for investors who want the potential rewards of bonds without having to invest in individual bonds directly.