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| Bond funds provide investors with important features like monthly income, portfolio diversification, professional money management, and daily liquidity. |
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| What is a Bond Fund? |
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| A bond fund pools money from many investors to buy individual bonds that meet the fund's investment objective. Each bond fund is professionally managed, and is categorized based on the type of bonds in which it invests. |
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– Bond funds normally own a number of individual bonds of varying maturities, so the impact of any one single bond's performance is lessened if that issuer should fail to pay interest or principal. Certain types of bond funds, such as broad market bond funds, are also diversified across bond sectors, providing exposure to corporate, U.S. government, government agency and mortgage-backed bonds. |
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– Professional portfolio managers and analysts have the expertise and technology to research the creditworthiness of bond issuers and analyze market information before making investment decisions. Fund managers identify which securities to buy and sell through individual security analysis, sector allocation, and yield curve positioning. |
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– Bond funds allow you to buy or sell your fund shares each day. In addition, bond funds allow you to automatically reinvest income dividends and to make additional investments at any time. For most bond funds, the minimum initial investment amount may be substantially less that what you would have to pay for a diversified portfolio of individual bonds. Depending on market conditions when you withdraw funds, your principal may be higher or lower than your initial investment. |
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– Most bond funds pay regular monthly income, although the amount may vary with market conditions. This feature can make bond funds an appropriate choice for investors who desire somewhat stable, regular income. If you do not wish to receive the monthly income, you can choose to have your dividends reinvested automatically as one of several dividend options. |
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– Many investors use municipal bond funds to help reduce their tax burden. Although municipal bond yields are generally lower than taxable bond fund yields, some investors in higher tax brackets may find they earn more from a tax-free, municipal bond fund investment instead of a taxable bond fund investment with a higher yield. Tax-free investments are usually inappropriate in tax-advantaged accounts such as IRAs. Read more about Taxable vs. Municipal Bond Funds. |
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| Risks of Bond Funds |
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| As with any investment, understanding the risks is very important. Bond fund risks include: |
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| If interest rates rise, bond prices usually decline, and if interest rates decline, bond prices usually rise. This inverse relationship is important to understand. The longer a bond's maturity, the greater the interest rate risk. A bond fund with a longer average maturity will see its net asset value (NAV) react more dramatically to changes in interest rates as the prices of the underlying bonds in the portfolio increase or decline. The effect that interest rates have on the prices of bonds owned by the fund will cause the income that the fund distributes each month to vary. |
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| Bonds carry the risk of default, meaning that the issuer is unable to make further income or principal payments. Many individual bonds are rated by a third party rating agency such as Moody's or Standard & Poor's to help describe the credit worthiness of the issuer. |
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| Bond funds are typically classified as investment grade-quality (medium – high credit quality) or below investment grade-quality, depending on the individual bonds in which they invest. Credit risk is a greater concern if the fund invests in lower-quality bonds such as high yield bond funds. The fund's prospectus will describe its credit quality policies. |
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| Other risks, such as default risk and call risk, are typically mitigated because a bond fund is made up of many individual bonds. By owning a large number of bonds, the impact of any one bond defaulting or being called away prior to maturity (forcing the fund to reinvest the proceeds at a lower, prevailing rate of interest), is lessened. |
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| Performance of a Bond Fund |
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| Because the performance of a bond fund is determined by the performance of its underlying investments, it may be helpful to review the basics of bond fund investing before looking closely at fund performance. However, past performance is not a guarantee of future results. |
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| Every bond fund has a net asset value (NAV), or share price, which is the dollar value of one fund share. The NAV is based on the value of all the securities in the portfolio and typically fluctuates daily. |
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| Yield of a bond fund measures the income received from the underlying bonds held by the fund. The 30-day annualized yield is a standard formula for all bond funds based on the yields of the bonds in the bond fund, averaged over the past 30 days. This figure shows you the yield characteristics of the fund's investments at the end of the 30-day period. It does not indicate the fund's future yield. The 30-day yield also helps you compare bond funds from different companies on a standard basis. |
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| A bond fund's total return measures its overall gain or loss over a specific period of time. Total return includes income generated by the underlying bonds themselves and price gains or losses of the bonds in the portfolio. Investors should focus on total return when evaluating performance of bond funds. |
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