Bond Funds are Fixed Income Mutual Funds
Bond funds are a type of mutual fund that invest in debt. Bond funds allow investors to indirectly lend money to private companies, governments, or other debt “instruments” in exchange for interest. The interest payments from the bonds are fixed – aka, always the same – and are used to pay regular dividends to the fund’s shareholders. Because of this, bond funds are sometimes called “Fixed Income” mutual funds, even though the dividends you receive may change over time as the fund buys and sells bonds.
Some fund shareholders opt to grow their investment by automatically reinvesting their dividends into more shares of the bond mutual fund, while others choose to take it as income. You can also earn money from bond mutual funds when bond fund shares increase in value.
The two main reasons investors might choose to invest in bond funds instead of simply buying bonds outright are the ability to buy and sell regularly, and to diversify risk.
There are two main categories of bond mutual funds:
- Government bond funds: These invest in either federal, state, or municipal bonds or bonds that are guaranteed by the U.S. government. Government bond funds typically have lower default risk and lower rate of return.
- Corporate bond funds: These mutual funds invest in bonds issued by private companies. Yields on corporate bonds, and the mutual funds that hold them, tend to be higher than government bonds, reflecting the increased risk of default.
Like with equity mutual funds, there are global and international versions of government and corporate bond funds. Experts recommend using the 30-day yield to compare the income streams of different bond mutual funds. The 30-day yield is an industry standard metric that helps investors project what a bond mutual fund’s interest might be for a full year, using a formula provided by the U.S. Securities and Exchange Commission.