The bond market has been a really competitive one lately, which is no real surprise given how people have a tendency to gravitate towards bonds during poor economic times and/or periods of great volatility within the stock market. For several investors, the question of individual bonds vs. bond funds is one that keeps them awake at nights. Which area of the bond market is the one where an investor should focus? To help you along with your bond market planning, here are some things to understand about individual bonds and bond funds:
-Individual bonds give you the investor a trusted source of income (investors typically receive the interest from these bonds twice per year) as well as the security of comprehending that the first investment (i.e. the principal) is likely to be returned after the bond matures. However, individual bonds may be sold by the investor before reaching their maturity date.
-Investors can approach bond funds as they'd the stock market. Bond funds are traditionally purchased by several individuals who pool their investment and then hand it over to a broker. While individual bonds supply a twice-yearly payment, bond funds usually offer payment on a monthly basis. However, that payment fluctuates significantly more than a person bond.
While many folks have the misconception that it is better to diversify with bond funds, in today's interest rate and bond market environment, it is clearly safer for an investor to buy a few individual bonds and get less diversification than putting any sum of money into a connection fund. The bonds in funds are always changing to keep the fund at a certain time frame and so the investor never really knows what bonds their capital is invested in. Having an individual bond, the investor knows exactly what's paying the principal and interest on each of the bonds. A 10 year bond fund has to keep that time frame so in 5 years an investor will still own a 10 year fund with various underlying securities than when he or she first bought it. When an investor buys a 10 year individual bond, in 5 years that same bond will then be described as a 5 year bond that may mature on a certain date.
With interest rates being only they currently are, it's very dangerous for an investor to place capital into a connection fund because when they wish to manage to get thier money-back, they will need to sell out of the bond fund that will be at a reduced price when interest rates start to rise. Having an individual bond when rates turn around, the investor continues to earn the first yield he or she bought the bond at and can reinvest their principal at the current rates when the bond matures. invest in bonds
-When buying a connection fund, it is obviously crucial that you ask the broker what issuers would be the underlying securities from, what's the revenue for these securities, and what ratings do the underlying securities have. In this manner the investor is fully alert to what he or she is putting their hard earned capital into. It can be important for the investor to ask what fees are associated with the bond fund since many funds have lots of fees that may eat into an investor's profit. Bonds funds are known if you are highly lucrative for brokers or salespeople.
An investor should also ask the broker what the SEC yield is when buying a connection fund. Many brokers quote the current yield of the fund which is more often than not higher compared to the SEC yield which is the actual return on the investment. When buying individual bonds the SEC Yield or yield to worst case scenario is nearly always quoted to the investor.
For someone that is worried with diversification, it is a common misconception an investor can get more diversification by way of a bond fund; this isn't true. When an investor buys a few different individual bonds, he or she is actually creating their own fund. The investor can tailor their portfolio or 'created fund' to their specific investment goals by picking and choosing the precise bonds that enter the portfolio. Not only will the investor get excellent diversification and have a portfolio fitting their specific needs, but he or she'll know the actual quality of each security he or she owns.
