The Case for Bond Funds
American Century Investments
Individual bonds can diversify investments, produce steady income and are generally less volatile than stocks.
Bond funds, which pool individual bonds into a single portfolio, offer the same advantages...and more:
Low minimum investments. To buy bonds through a licensed broker usually requires a minimum of $5,000 to $25,000. Investing with a broker may also involve sales charges and commissions. And although load funds also involve sales charges, no load funds do not.
Bond mutual funds, on the other hand, often feature minimum investments of around $2,500 and may include a portfolio of 100 individual bonds.
Diversification. A portfolio of 100 bonds at an average investment of $10,000 each would require $1,000,000.
Bond funds, meanwhile, enable you to purchase a more diversified portfolio of bonds than you otherwise might be able to afford. Bond funds may also reduce your overall investment risk. A diversified portfolio of stocks and bonds can help smooth out volatility and produce a more balanced investment. That's because stocks and bonds respond differently to changes in the economy (see chart below).
Professional Management. Investors generally rely on themselves or brokers to monitor their individual bonds.
Experienced managers monitor bond fund portfolios with an emphasis on maximizing returns and minimizing risk.
Convenience and Accessibility. The sale of individual bonds requires finding a buyer on the open market.
When you want money from a bond fund, you simply sell enough shares to equal the amount you need (taxes will be due on any profit you realize).
A Word About Income. Bond funds are well suited for investors who want steady income, perhaps to supplement other retirement assets. But you'll need to balance your desire for income with your tolerance for risk because funds that offer the highest yields typically involve more risk.
For the highest possible level of income, you may want to consider corporate high-yield bond funds or long-term bond funds. High yield bonds are subject to increased credit and liquidity risks. Long-term bonds involve greater interest rate risk than shorter-term bonds.
Income investors seeking to balance risk and reward might consider funds that invest in mortgage-backed securities, including GNMAs, which carry a government guarantee and pay relatively high interest rates. (Remember, fund shares are not guaranteed.) Not all bond funds pay current income. With zero-coupon bond funds, for example, shares rise in value until a
specified maturity date, when principal and accumulated interest is returned in a single payment.
Some investors prefer these funds for goals they hope to reach on a certain date, such as college, because they know in advance approximately how much these investments will be worth when they mature. Returns on these funds are not guaranteed, however.
No Free Lunches. There is a price for the advantages that bond fund investing offers. On average, bond fund expenses run $9.10 for every $1,000 investment.¹ In addition, bond funds (aside from zero-coupon funds) generally have no maturity date. Instead, fund managers purchase many different bonds with varying maturities. So there is no assurance you'll get your principal back at a predetermined date.
Because bond funds generally own an ever-changing portfolio of bonds, the interest rate paid to investors, and the share price of the fund, fluctuates with market conditions. Investors seeking to diversify, reduce risk or increase their income should carefully consider the advantages and
disadvantages of both bonds and bond funds before deciding which to add to their investments.
Questions & Answers:
Why do bonds with longer maturities offer higher interest rates?
In general, the securities markets reward risk-takers; the greater the risk, the greater the potential reward. Since bond prices
rise and fall based on changes in interest rates, it follows that the more time before your bond matures, the greater your exposure
to interest rate fluctuations. Therefore, bonds with longer maturities typically offer higher interest rates than other types of
bonds as a reward for their greater exposure to risk.
What is the difference between yield and total return?
A bond fund's yield refers to the interest paid by the bonds it owns, expressed as an annual percentage rate based on share price.
A fund's total return considers its yield and another critical factor - changes in share price. Therefore, total return is a better
measurement of your fund's overall performance.
| Total Return of Stocks and Bonds During Market Downturns |
| |
July to Oct., 1990 |
Aug. to Dec., 1987 |
Jan. 1973 to Oct. 1974 |
| Bonds |
2.93% |
2.98% |
6.19% |
| Stocks |
-14.1% |
-21.42% |
-33.12% |
Stocks and bonds often respond differently to market turbulence.* As this chart shows, while stocks fell significantly during
these three market downturns, bond values rose. Including bonds in your investments may help soften the stock market's downturns.
Past performance is no guarantee of future results.
This information is for educational purposes only and is not intended as investment advice.
* Source: Morningstar®, Inc.
* Stocks = S&P 500 Index Bonds = Lehman Bros.Intermediate
Government/Corporate Bond IndexSource: Ibbotson Associates.
This article is from the Financial FYI® series produced by the Education and Guidance department of American
Century Investments. "Financial FYI" is a registered mark of American Century Services Corporation.
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