How do individual bonds differ from bond mutual funds, and why would you invest in one over the other? Financial Educator Scott Huband, CFP® outlines the main differences between the two.
Today’s question is what’s the difference between a bond and a bond fund? So once you’ve decided you want to include bonds inside of your portfolio, you have essentially two main options. You can invest in individual bonds or you can invest in bond mutual funds.
Starting with individual bonds, the key distinction here is that bonds pay a fixed rate of interest so you can know ahead of time exactly what your rate of return will be, assuming of course you hold the bond until maturity and that the issuer doesn’t default. Now, it’s harder to get diversification using individual bonds, depending on the amount of dollars that you have, so a lot of investors choose to invest in bonds through bond mutual funds.
The concept here is similar to a stock mutual fund where you’re pooling your money with other individual investors. Only in this case, instead of buying and selling stocks, a portfolio manager is buying and selling individual bonds inside of the fund. The downside to this approach is that you have less control over the process and often the bonds aren’t held to maturity, and so you can’t know ahead of time exactly what your rate of return will be. But it still is a good way to invest in bonds in a diversified way. In addition, bond mutual funds for the individual investor are often far less expensive than buying individual bonds.
Those are the main differences between bonds and bond mutual funds. For more information visit PureFinancial.com.