Fixed Income
Bonds vs. Bond Funds
| Investment Considerations |
Bonds |
Bond Funds |
Fixed income |
Offer predictable income stream known at the time of purchase |
Interest payments vary based on bonds that the fund's manager buys and sells, and on current market rates. |
Principal protection |
The amount of principal (i.e., par value) that will be returned at maturity is known at the time of purchase subject to credit worthiness of the issuer. |
Since bond funds do not mature and their prices change daily (net asset value), it may difficult, if not impossible, to predict the value of an original investment at the time of sale. |
Costs |
Either a one-time commission or an annual fee and low individual transaction charges are paid when a bond is bought and sold |
Sales fees and commission are charged; In a case of a no-load fund, annual management fees typically apply |
Capital gains taxes |
Paid only if a bond is sold for profit prior to maturity date |
- Paid if shares are sold for profit
- Paid when a fund manager sells bonds for profit (managers buy and sell bonds during the year, capital gains or losses are passed to investors) Investors may be liable for tax on imbedded gains even if they have not enjoyed the returns. |
Knowing what you own |
Investor knows exactly what bond is bought, its credit rating, coupon rate and maturity date. 100% of the money is invested and earning interest. |
Investor only knows the main objective of the bond fund (e.g., intermediate-term corporate bond fund), which may be changed by the fund manager, this is called “style drift.” In addition, bond funds are not fully invested, holding cash for administrative needs and redemptions. |
Diversification |
Several bonds are needed to achieve proper diversification. Remember: do not put all your eggs in one basket. |
Greater diversification is achieved with one investment because funds invest in hundreds of bonds. |
Conclusion: Whether to invest in individual bonds or bond funds is every investor’s personal decision based on investment objectives and factors that apply to his or her particular situation.
Investors should carefully consider the investment objectives, risks, charges and expenses of bond funds before investing. The prospectus contains this and other information about the funds. The prospectus is available from your financial advisor and should be read carefully before investing.
Diversification does not ensure a profit or protect against a loss. Investing involves risk and investors may incur a profit or a loss.
Asset allocation and diversification do not protect against a profit or a loss.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
Next: Bond Portfolio Evaluation and Reporting