December 2, 2011

Are Bond Funds A Good Idea?

As most investors know, bonds are a good idea and in fact, if you follow this blog, listen to me on the radio or seen any article I've written, then you know I am a proponent of having your age as a percentage in fixed income some of which should be invested in bonds.

But bond funds are different.  Bond funds typically buy bonds of different maturities from different entities, corporate, country, junk, etc and charge you a fee to manage it.  It doesn't matter what type of bond fund it is, the commonality is that when interest rates go up, the bonds inside the fund will decrease in value and if you own a bond fund while interest rates are rising, it'll be hard for that bond fund to make you any money.

Take note that many bonds use leverage as well and while that works in your favor sometimes, when interest rates do rise, bond funds that have leveraged themselves to give investors a few extra basis points in yield will get crushed, as they did in 1994.

Bonds too will go down in value but not if held to maturity and that's where you have an advantage over a bond fund, you don't have to be fully invested in bonds whereas they do.  When a bond matures, you can reinvest the principle back into a new bond paying a higher rate and not have to pay a percentage to do it!

1 comment:

  1. I will never own bond funds again, only bonds.