Bond Mutual Funds
What are bond mutual funds?
Just like stock mutual funds invest in a variety of stocks, bond mutual funds invest in a variety of bonds and other debt instruments. A debt instrument is different from an equity instrument. An equity instrument gives the holder ownership. Stock is an equity instrument. When you own a share of stock, you own part of that company.
A bond is a debt instruments. If you buy a bond, you are lending money to the company and they are indebted to you. A bond mutual fund contains debt instruments of different risks, companies, and government bonds.
What are the benefits to having bond mutual funds?
Because bonds are usually less risky, unless you get into junk bonds, bond mutual funds are often less risky as well. This makes them appeal more to the retirement or close to retirement crowd.
Keep in mind that with less risk you get a smaller return. For example, if you invest in a penny stock (stocks of new companies that cost less than a dollar) you have the possibility to make a very large return, much more than the average return of the stock market. But, it is very risky because there is a good chance that the company could go out of business. It will either have incredible growth that you can cash in on, or it will be a total dud and you will lose all your money.
On the other hand, you can eliminate the risk almost completely by investing in government bonds, but your return will be minimal. This is why bonds are usually less risky with a smaller return. Still, there are bonds that are very risky, often called junk bonds. These can be just as risky as some stocks with the only difference being that they are debt instruments and not equity.
Another benefit of bonds is that when a company goes bankrupt or out of business, they have to pay the debtors first. Stockholders rarely get any piece of the pie.
When should I invest in bond mutual funds?
If you’re over 30, bonds will most likely take some part in your investment portfolio. In your 30s and 40s, they should be minimal, which could be taken care of by holding a mutual fund with stocks and bonds. If you are retired or close to retirement, you can increase your holding of bonds.
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