With almost no place for interest rates to go but up, the distinction between individual bonds and mutual funds that invest in bonds is becoming increasingly important.
With almost no place for interest rates to go but up, the distinction between individual bonds and mutual funds that invest in bonds is becoming increasingly important.
Rightly or wrongly, investors generally view high-quality bonds as low-risk investment vehicles. That's because they know they will receive a stated return until the bond matures, at which point they get their principal back.
Not surprisingly, the economic downturn and the stock market's collapse in 2008-09 prompted many investors to seek the perceived safety of bonds and mutual funds that invest in bonds.
But bond funds are entirely different from individual bonds, said Brent Burns, president and co-founder of Asset Allocation LLC, which specializes in helping financial advisers use individual bonds to derive a steady stream of income for their clients.
“A bond is a legal obligation,” Mr. Burns said today at the National Association of Personal Financial Advisors' annual conference in Salt Lake City. “A bond fund is a mutual fund.”
As a mutual fund that invests in hundreds of individual bonds, bond funds pay investors a return based on the average return of all its holdings. As a result, bond funds have a tendency to go up and down — sometimes dramatically.
The distinction between bonds and bond funds becomes particularly relevant in a falling-interest-rate environment, Mr. Burns said.
“Bond funds are required to recognize their losses,” he said. “If you hold on to individual bonds until they mature, you really don't have to recognize any losses. Essentially, you've put a floor on any losses.”
