Bond funds are similar to bonds in that they provide income and may increase in value, but are unlike bonds in some fundamental ways. Bond funds do not pay a fixed interest rate, have a maturity date, or guarantee repayment of principal at some known future date. This is because they buy a variety of bonds, each with its own interest rate and term, and typically sell the portfolio holdings before they reach maturity.
Bond funds offer some advantages over buying bonds directly: They are diversified, you can reinvest your distributions to purchase more shares, and the investment minimums are often less than those of bonds.
You can choose a fund based on your risk tolerance and/or tax strategy: investment-grade corporate bond funds if you're interested in stability, or volatile junk bond funds if you're looking for higher returns. For greater security against default, you can choose short-term or long-term
Bond-fund investors must be aware of two major factors that drive the performance of bonds: interest rates and credit quality.
- As interest rates rise, bond prices fall, and vice versa.
- The value of bond funds holding longer maturity issues tend to rise and fall more sharply as interest rates change, while those with shorter maturities tend to be less volatile.
- Similarly, bond funds holding issues of higher credit quality tend to be less sensitive to changes in the economy than those holding lower-quality bonds.
Balanced funds invest in both stocks and bonds. They tend to be less volatile than stock funds because their performance does not rely upon the performance of one asset class. You can find out how the fund's portfolio is allocated between the asset classes in the fund's prospectus.
Diversification does not assure a profit, or protect against loss, in a down market.
Investors should consider the investment objectives, risks, charges, and expenses of a mutual fund carefully before investing. A prospectus contains this and other information. A mutual fund prospectus is available through www.scottrade.com or through a Scottrade branch office. The prospectus should be read carefully before investing.