Bond Funds vs. Individual Bonds
What Are the Differences Between Investing in Bond Funds and Individual Bonds?
Bond Mutual Funds
Mutual funds pool together capital from many investors who share similar investment goals. Bond mutual funds can invest in any type of fixed income security except CDs. The major categories of fixed income mutual funds include:
- Taxable Bond Funds. These offer a wide range of choices depending on your investment objective. Some invest in corporate securities or U.S. government securities. Others invest in high-risk, high-income securities or low-risk, lower-income securities.
- Tax-Free Bond Funds. Federal tax-exempt bond funds seek to provide high after-tax income and invest in a variety of municipal bonds issued within a number of different states. State-specific funds invest in bonds issued within one state to obtain income that is exempt from federal, state and sometimes local, income tax.
- Taxable and Tax-Free Money Market Funds. These provide current income while seeking to maintain a constant share price.
Unit Investment Trusts (UIT)
A UIT is a package of income-producing securities that is purchased and held in a trust until the final amount is paid. UITs invest in a wide range of issues, from treasury to corporate to municipal bonds. Once the portfolio is assembled, the securities are monitored but not actively managed.
UITs charge an annual fee that is deducted from yield. There is also an initial sales charge paid to the sales representative. Sales charges may range from 1 to 5%. UITs are offered on a “dollar price” basis, with return expressed in terms of estimated current return (net interest income divided by public offering price).
You can buy individual bonds for your portfolio the same way you buy stocks. Unlike stocks, however, bond availability and price vary from dealer to dealer. Large bond dealers maintain an inventory of bonds, which may not be available through other dealers.
Bonds are generally offered on the basis of yield to maturity, which can be hard to follow and compare. While some yields are quoted in financial pages of newspapers, these are only a small fraction of available bonds, and represent rates that apply to institutional-size trades. From the yield to maturity, bond prices are calculated and quoted as a bid price (the price at which you sell) and offer price (the price at which you buy). Generally, you can expect to get better prices as the size of the order goes up.