The bond market has been a really competitive one lately, which can be not surprising given how people tend to gravitate towards bonds during poor economic times and/or periods of great volatility within the stock market. For a lot of investors, the question of individual bonds vs. bond funds is one that keeps them awake at nights. Which area of the bond market is the main one where an investor should focus? To help you with your bond market planning, here are a few things to understand about individual bonds and bond funds:
-Individual bonds supply the investor a reliable source of income (investors typically have the interest from these bonds twice per year) as well as the security of realizing that the first investment (i.e. the principal) will undoubtedly be returned once the bond matures. However, individual bonds can be sold by the investor before reaching their maturity date. invest in premium bonds
-Investors can approach bond funds as they'd the stock market. Bond funds are traditionally purchased by several those who pool their investment and then hand it over to a broker. While individual bonds give a twice-yearly payment, bond funds usually offer payment on a regular basis. However, that payment fluctuates significantly more than an individual bond.
While many individuals have the misconception that it is better to diversify with bond funds, in today's interest rate and bond market environment, it is actually safer for an investor to purchase a few individual bonds and get less diversification than putting any amount of cash into a connection fund. The bonds in funds are always changing to help keep the fund at a certain time period and so the investor never truly knows what bonds their capital is invested in. By having an individual bond, the investor knows exactly what is paying the principal and interest on each of their bonds. A 10 year bond fund has to help keep that point frame so in 5 years an investor will still own a 10 year fund with various underlying securities than when he or she first bought it. When an investor buys a 10 year individual bond, in 5 years that same bond will be a 5 year bond that will mature on a certain date.
With interest rates being as little as they currently are, it is very dangerous for an investor to put capital into a connection fund because when they wish to obtain money-back, they will have to sell from the bond fund which is at a reduced price when interest rates commence to rise. By having an individual bond when rates change, the investor continues to earn the initial yield he or she bought the bond at and can reinvest their principal at the present rates when the bond matures.
-When buying a connection fund, it is always important to ask the broker what issuers would be the underlying securities from, what is the revenue for these securities, and what ratings do the underlying securities have. This way the investor is fully conscious of what he or she's putting his / her hard earned capital into. It is also very important to the investor to ask what fees are related to the bond fund as most funds have plenty of fees that will eat into an investor's profit. Bonds funds are known if you are highly lucrative for brokers or salespeople.
An investor should also ask the broker what the SEC yield is when buying a connection fund. Many brokers quote the present yield of the fund which can be typically higher than the SEC yield which can be the actual return on the investment. When buying individual bonds the SEC Yield or yield to worst case scenario is nearly always quoted to the investor.
For somebody that is worried with diversification, it is just a common misconception an investor can get more diversification by way of a bond fund; this is simply not true. When an investor buys a few different individual bonds, he or she is actually creating their own fund. The investor can tailor their portfolio or 'created fund' to his / her specific investment goals by picking and choosing the particular bonds that get into the portfolio. Not only can the investor get excellent diversification and have a portfolio fitting their specific needs, but he or she'll know the actual quality of each security he or she owns.
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