If you are considering investing in bonds, you may have also considered bond funds or may already be invested in bond funds. There are substantial differences between owning a bond fund and owning a portfolio of bonds.
A bond fund is comprised of numerous bond issues with varying maturities. When a bond in a fund matures, the fund manager will reinvest the proceeds in a new bond. As a result, there is no finite end date with a bond fund like there is with a bond. You are not guaranteed to get your principal back on a given date.
We will cover the difference between bond funds and individual bonds in one of our supplements. The main advantage of buying individual bonds or even CDs is that you are 100% certain that at the maturity date, barring default, you are going to get your money back. At this point, you can decide how you want to reinvest it.
Owning a portfolio of bonds will give you more control over the timing of maturities and allow you to maintain control as to how reinvest the interest received. When you are buying a bond fund, you are buying a portion of a portfolio of bonds, but you do not get the principal back at a certain date. As a result, you will ultimately exit the bond fund at the fund’s Net Asset Value at some point in the future, which is not guaranteed.
Many times, the professional management of a bond fund may be attractive to you if you find selecting your bonds to be intimidating. If you are really diligent, one method is to look at the bond holdings of the bond fund you are considering. You can do this on BondFunds.com, Morningstar.com, on the fund’s website, or through the SEC website. All bond funds have to disclose what they hold. You can look at the highest quality bond holdings the fund owns and see if you feel comfortable buying any of the bonds in the fund by yourself.
For many financial advisors, it is much easier (and more profitable) to simply recommend a bond fund than it is to assist their clients in selecting bonds one at a time. If you want a guaranteed return of principal on a given date, buying individual bonds on your own are the way to go.