Retirement Funds —
Bond Funds
Bond Mutual Funds
Bond funds: Instead of purchasing individual securities, an investor might
decide to purchase shares of a bond mutual fund. Advantages include broad diversification,
liquidity, and on-going professional management. In addition, bond fund accounts
can sometimes be opened for $500 or less, making them attractive for persons
with small dollar amounts to invest. The biggest disadvantage of bond mutual
funds is that, unlike individual securities and UITs, there is no fixed maturity
date. Thus, the price of shares is always subject to fluctuation with changes
in interest rates, and an investor could lose principal if interest rates increase.
As with all mutual funds, the key factors to look for when selecting a bond
fund are historical performance and expenses. Unlike stock funds, that have
the potential for capital appreciation to offset fund expenses, bond funds
must rely on low management costs to enhance their returns. In addition, bond
funds generally invest in similar securities (e.g., Treasuries), so most of
the difference in return among bond funds is due to differences in cost. The
average annual expense ratio (expenses as a percentage of fund assets) for
bond funds is about 1% ($1 for every $100 invested), but there are some low-cost
fund families like Vanguard, T.Rowe Price, TIAA-CREF, and Fidelity that charge
significantly less.
A 1997 study of bond mutual funds by Consumer Reports magazine found
that, among government bond funds, funds with low expense ratios outperformed
their peers. One low-cost bond mutual fund is a bond index fund. Bond index
funds purchase the same securities that comprise a benchmark bond index, such
as the Lehman Brothers Aggregate. Since the portfolio of securities is pre-determined
by whatever bonds comprise an index, trading costs are minimal and bond index
fund management expenses are low. Like individual bonds, bond funds with the
longest maturities are extremely volatile when interest rates fluctuate. Conservative
investors should select short-term bond funds consisting of investment-grade
securities.
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