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July 05, 2019

Bond Funds Explained

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When it comes to bond investing, it’s important to know what you own, and that’s especially true with bond funds. It’s always important to make sure that a given bond fund matches your risk tolerance and investing time horizon, and how it may fit with your overall investment portfolio. I’m Collin Martin, and this is Bond Market Today.

Bond funds come in many different shapes and sizes, and it can be difficult to know where to start. There’s bond mutual funds and bond exchange-traded funds. There’s actively-managed funds and passively-managed funds, and there’s a lot of different bond fund categories that dictate what type of investments the bonds can invest in.

Now, there’s a lot of things you can consider when deciding if a bond fund is appropriate and how it may react to certain interest rate changes or risks to the economy, but here are just a few things to consider.

The first is know what the bond fund owns. Does it invest in safe investments like U.S. treasuries, or highly-rated corporate or municipal bonds; or does it have riskier holdings like high-yield bonds, bank loans, or emerging market debt? Depending on the underlying credit quality of the holdings, performance can vary significantly depending on the market conditions.

The second thing to consider is the average duration of a bond fund. Duration is a measure of interest rate sensitivity. A bond fund with a low-average duration will generally be less sensitive to interest rate fluctuations than a bond fund with a higher duration.

And a third thing to consider is what is the bond fund allowed to do? Some bond funds are meant to track an index, others are meant to beat an index, and other bond funds are considered go anywhere funds that can invest generally wherever the portfolio manager sees fit, depending on his or her market outlook.

Now, there can be pros and cons to any of these approaches, but this last point is important when deciding how a bond fund can fit into your overall portfolio. Bonds are meant to provide income and diversification benefits. We think they should be the ballast for your overall portfolio, but if you don’t know what a bond fund owns or how it’s going to react given changing market conditions, then it might not provide the benefits that you’re looking for.

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When it comes to bond investing, it’s important to know what you own. That’s especially true with bond funds. It’s always important to make sure that a given bond fund matches your risk tolerance and investing time horizon, and how it may fit with your overall investment portfolio. Collin Martin breaks down bond funds on this episode of Bond Market Today.

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Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and the author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risks, including loss of principal.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

High-yield bonds and lower rated securities are subject to greater credit risk, default risk, and liquidity risk.

Tax-exempt bonds are not necessarily suitable for all investors. Information related to a security's tax-exempt status (federal and in-state) is obtained from third parties, and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the alternative minimum tax. Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

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