Investing in Bond Mutual Funds

By Stock Research Pro • February 12th, 2009

A bond represents an investment in municipal, government, or corporate debt. Bond mutual funds can be a good choice for conservative investors who, rather than take on high risk in search of superior returns, seek to protect their principal while earning a regular income. Using the money invested by shareholders, professional money managers buy and sell bonds for the fund’s portfolio in a manner that is consistent with the fund’s investment objective.

A Popular Investment Choice

With thousands of funds to choose from, bond mutual funds have become a popular way to invest in the bond market. As you might imagine, bond funds are very popular with retirees and older Americans seeking a low-risk, income-providing investment. However, just like other types of investments, bonds and bond funds are not completely without risk as their prices can and do fluctuate.

Instant Diversification

Similar to other types of mutual funds, the dollar value of one share in the fund, the net asset value (NAV) is the price that investors pay to purchase shares in the fund or receive when they sell shares in the fund. Each share represents a proportional ownership interest in fund’s portfolio. This pooling of shareholder resources enables the fund manger to invest in a variety of bonds in an effort to minimize shareholder risk. Investors in bond funds will typically receive regular dividends from the fund that reflect any accrued interest or capital appreciation in the bonds held within the fund.

Tax-Exempt Status

Many bond funds invest in tax-exempt municipal bonds which, depending on your state, may be exempt from both state and federal income tax. As not all of the income received from a municipal bond fund may be tax-exempt, it is advised that you review the fund’s prospectus before investing.

The different types of bond mutual funds include:

Government Bonds: Issued by the U.S. Treasury and considered the highest quality bonds as they are backed by the full faith and credit of the U.S. government.

Corporate Bonds: Issued by corporations to finance business expansion or other needs. These bonds are rated based on the likelihood that interest will be paid in a timely manner and that the principal will be delivered to the investor at maturity.

Municipal Bonds: Issued by governments and municipalities, they offer income that is usually free from state and/or federal income taxes. A portion of their income, however, may be subject to the Federal Alternative Minimum Tax (AMT). Due to their tax advantages, municipal bonds are often a good option for investors in higher tax brackets.

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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