Bonds vs. Bond Funds
Rate this article: Thank you for rating this article.

By Dow Jones

Bonds are complex — there's no doubt about it, especially if you're a novice investor with little experience in the markets. That's why a lot of people opt for the greater simplicity offered by bond funds when they seek to diversify their investments with some fixed-income exposure. If you're willing to put in the effort (and the cash), you may be better off buying individual bonds instead of bond funds. But in the real world, a fund is sometimes worth the convenience.

Here's what you have to consider:

Like an equity mutual fund, a bond fund is managed by a professional investor who buys a portfolio of securities and makes all the decisions. Most funds buy bonds of a specific type, maturity and risk profile — long-term corporates, for instance, or tax-free municipals — and pay out a coupon to investors often monthly, rather than annually or semiannually like a regular bond.

The chief advantage of a bond fund is that it's convenient. It's also true that when it comes to buying corporate and municipal bonds, a professional manager backed by a strong research organization can make better decisions than the average individual investor. Consequently, if you want to dabble in junk bonds or shelter your income with high-yield muni bonds, you may be better off going the easy route and picking a good fund.

Of course, the cash outlay required to build a decent bond portfolio could be another reason why a bond fund might make more sense for you. Bonds — especially municipals — typically sell in $25,000 lots to individual investors. And while you can find a few offerings in the $10,000 or even $5,000 range, you won't have as much selection. So if your nest egg is not yet large enough to comfortably meet the high minimums associated with building a diversified bond portfolio, bond funds are a good alternative. These funds typically have minimum investment requirements of just $1,000 to $3,000.

The disadvantage of a bond fund is that it's not a bond. It has neither a fixed yield nor a contractual obligation to give investors back their principal at some later maturity date the two key characteristics of individual bonds. Then there are the fees and expenses that can cut into returns. Finally, because fund managers constantly trade their positions, the risk-return profile of a bond-fund investment is continually changing: Unlike an actual bond, whose risk level typically declines the longer it is held by an investor, a fund can increase or decrease its risk exposure at the whim of the manager.

The other thing about building your own portfolio of bonds is that you can tailor it to meet your circumstances, meaning the bonds will mature precisely when you need them. For instance, many parents saving for college bills buy zero-coupon bonds whose maturities match their child's enrollment year. A bond fund cannot deliver that sort of precision.

Rate this article: Thank you for rating this article.

Important Investment Risks
Bond values fluctuate in price so the value of your investment can go down depending on market conditions. The two main risks related to fixed-income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. High yield securities (commonly known as "junk bonds") offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a junk bond issuer's ability to make principal and interest payments. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some investors may be subject to Alternative Minimum Tax (AMT), interest income from certain municipal securities is included in calculating the tax. You may want to consult your tax advisor concerning an investment in municipal securities and mutual funds that invest in municipal securities.

For more complete information on any mutual fund, please request the fund's prospectus and/or, if available, the summary prospectus by contacting a Merrill Edge Investment Specialist at 1.877.653.4732 and read it carefully. Before investing, carefully consider the investment objectives, risks, and charges and expenses of the fund. This and other information can be found in the fund's prospectus and/or, if available, summary prospectus.

© Dow Jones. All rights reserved.

This material is authored by Dow Jones and was not authored by Merrill Edge. Assumptions, opinions and estimates constitute judgment from Dow Jones as of the date of this material and are subject to change without notice. Past performance does not guarantee future results. The information contained in this material does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security, financial instrument, or strategy. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue.

Any tax statements contained herein were not intended or written to be used, and cannot be used for the purpose of avoiding U.S. federal, state or local tax penalties. Neither Merrill Edge nor its representatives provide tax, accounting or legal advice. Clients should review any planned financial transactions or arrangements that may have tax, accounting or legal implications with their personal professional advisors.