Why Own a Bond Fund?
Fidelity Investments
Bond funds provide investors with important features like monthly income, portfolio
diversification, professional money management and daily liquidity.
What is a bond fund?
A bond fund, like all mutual funds, is a "group investment" which is professionally managed.
To pursue the goals of the fund, a fund is usually made up of individual bonds similar in maturity, quality, and type of issuer.
Most bond funds pay regular income however, the amount of each payment may vary with market conditions. During periods of
extreme market fluctuations, a bond fund may not provide the amount of income originally anticipated.
However, its share price will fluctuate less than a stock fund.
Important advantages of bond funds:
Regular monthly income
The interest income earned by bond funds is generally higher than the interest earned by investments such as money market
funds, certificates of deposit, or bank savings accounts, although they carry more risk*. This can make them attractive to
investors such as retirees, who are looking for a source of regular income. A typical bond fund pays virtually all of its
interest income as a dividend distribution each month. Investors can receive these dividends as cash or to have them
automatically reinvested. In contrast, individual bonds generally pay interest at six-month intervals, and those payments
cannot automatically be reinvested.
Diversification
Investing a portfolio in securities with different risk levels is one way to achieve diversification. In general, bonds are
considered to carry less risk than stocks and therefore are used to help investors reduce their exposure to market volatility.
Using bond funds to diversify a portfolio can help investors reduce their risk of loss while still
maintaining the potential for a competitive return.
The table below illustrates how diversifying with bond investments can help cushion a portfolio against market risk.
| If you owned: |
Your average
return was |
The single largest
one-year gain: |
The single largest
one-year loss: |
100% stocks
0% bonds |
11.25% |
42.56% |
-29.73 |
80% stocks
20% bonds |
10.35% |
33.99% |
-24.34% |
60% stocks
40% bonds |
9.29% |
25.41% |
-18.96% |
This hypothetical chart is based on performance of common stocks (as measured by the S&P 500®) and long-term
government bonds (as measured by a bond portfolio constructed by Ibbotson) for the period 1926-7/1999. Source:
Ibbotson Associates,® Chicago, Analyst Software. Used with permission. All rights reserved. The indexes are
unmanaged and include dividend reinvestments for the S&P 500. Unlike common stocks, U.S. government bonds
offer a fixed rate of return and guarantee payment of principal (if held to maturity). Unlike U.S. government bonds,
mutual funds are not insured or guaranteed by the U.S. Government. Not intended to imply past or future
performance of any Fidelity fund.
Investing in bond funds rather than individual bonds also helps diversify a portfolio. An individual bond investor has the potential
of losing all of their money if the issuer defaults. In contrast, a bond fund holds hundreds of different bonds from different issuers,
reducing the effect if one issuer fails to pay interest or principal.
Professional management
Professional portfolio managers and analysts have access to research and market information that individual investors do not.
Fund managers identify which securities to buy and sell through individual security analysis, focusing on issuer credit and
bond structure to supplement published information. All of this is of great advantage to investors, who do not have time to
research individual bonds themselves.
Liquidity and flexibility
Bond funds allow you to add or withdraw money at any time. Many bond funds offer checkwriting on your balance for easy and immediate
access. Bond funds allow you to automatically reinvest income dividends and to make additional investments at any time. These
benefits are generally not possible for individual bonds, because most bonds cost hundreds or thousands of dollars each and must be
traded through a brokerage account.
Tax-free income
Many investors use municipal bonds and money market funds to help reduce their tax burden. Although municipal bond yields are
generally lower than taxable bond yields, some investors in higher tax brackets may find they earn more from a tax-free municipal bond
investment instead of a taxable investment with a higher return.
* Mutual fund shares are not deposits or obligations of or guaranteed by any depository institution. Shares are not
insured by the FDIC, Federal Reserve Board or any other government agency, and are subject to investment risk,
including the possible loss of principal amount invested.
An investment in a money market mutual fund is not a deposit of a bank and is not insured or guaranteed by the
Federal Deposit Insurance Corporation or any other government agency. Although a money market mutual fund
seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in a
money market mutual fund.
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