With skyrocketing interest rates, investors are looking for a way to make more money. Yield-seeking investors have started looking at bond funds, which can offer diversification and professional management.
How’s the fund’s performance?
Just because the pros manage mutual funds, that’s no guarantee of returns. In fact, when a mutual fund company buys bonds, owners of the fund still must accept certain risks. One example is “interest rate risk,” which means that as interest rates rise, bond values fall. Therefore, the money you invest in a bond fund can decrease during periods of rising interest rates (like we’re experiencing at the writing of this piece). And the opposite is true, too. If you own a bond fund, and interest rates in the world drop, the bonds inside the fund will appear more attractive on the market and the value of the fund should appreciate. A fund’s sensitivity to fluctuations in interest rates depends, among other things, upon the duration of its holdings. Bonds with a longer duration tend to be more volatile than bonds with shorter durations.
What if the fund buys “junk”?
Another influence on a bond fund’s performance comes from the credit quality of the bonds it holds. Credit quality refers to the creditworthiness of the company or entity issuing the bonds as determined by bond rating agencies. Perhaps you’ve seen ratings such as “AAA,” “BB,” etc.? The more “A’s,” the higher the credit quality.
“High-yield” funds usually involve more risk because they buy low-quality bonds (often called “junk bonds”). High credit-quality bond funds include investment holdings with high average credit values. These normally have lower yields than junk bond funds. It’s a tradeoff: safety vs. return.
Knowing the duration and credit quality of the bonds in a fund allows you to determine the risk level of your investment.
Diversifying your bond investments
Getting the right mix of bond types is important for achieving a well-rounded investment portfolio. The mix that works for you depends upon your investment goals and the amount of risk you feel fits your situation.
Investing in bond funds does not require the same knowledge as is required to select individual bonds in which to invest, which is why many people prefer funds. Always read the prospectus before investing, and if you need help looking at the bonds in your portfolio or want to hear more, call 02-624-2788.
Douglas Goldstein, CFP®, is the director of Profile Investment Services, Ltd. www.profile-financial.com. He is a licensed financial professional both in the U.S. and Israel. Call (02) 624-2788 for a consultation on how to set up your American assets to meet your financial goals. Securities offered through Portfolio Resources Group, Inc. Member FINRA, SIPC, MSRB, FSI. The opinions expressed are those of the author and not those of Portfolio Resources Group, Inc. or its affiliates. Neither PRG nor its affiliates give tax or legal advice.
Published November 24, 2014. Updated January 2023