• The IMF predicts the US economy to slow down.
• The outlook for Western Europe and Japan isn't too great either.
• Headline inflation has increased in both advanced as well as emerging economies.
• Oil price has doubled over the last six months.
• There is a possibility of deeper economic downturn.
• The stock markets of most of the countries have tumbled during recent times.
These sentences are not something new for regular readers of newspapers, especially financial newspapers. Everybody would have been affected as a result of the consequences of these statements. During tough times such as these, where would you put your money? Stock market - No that would be suicidal! Banks - rate of return would be too low. Then where?
One possible place is mutual funds. They are a lot safer than shares and earn better returns than banks. But one must be careful while choosing a mutual fund during recession times. It is always a better bet to invest in bonds during recession. It ensures regular interest payments and possible capital appreciation when bond price increases. Bond mutual funds enable you to get just that.
As the name suggests, these funds invest in bonds and debt securities. They aim to protect the invested capital and at the same time ensure regular income from interest payments. Just like any other mutual fund, they too have a Net Asset Value (NAV) which is the value of each share of the mutual fund. It is nothing but what one must pay to get one share of the fund or what one gets when a share is sold.
5 reasons why one should invest in bond mutual funds:
1. They are a lot less riskier than stocks
2. They provide stability
3. They are diversified - the portfolio will be across many different bonds thereby reducing the risk of default and ensure regular payments.
4. Some of them are exempt from federal and/or state taxes
5. They are more liquid than bonds.
Among these advantages, the last one is the most important. It is the reason why one must buy bond mutual funds rather than individual bonds. They can be easily bought and sold in smaller units. On the other hand, it is not so easy to buy bonds and hold them. Bonds are not as liquid as bond funds. Hence it is better to buy bond mutual funds rather than bonds.
TYPES OF BOND FUNDS
There are many different types. Of these, some of the major ones are Government ones (or Federal bond funds), Municipal ones, corporate ones etc.
Government Bond Funds
They invest in debt securities issued by the government such as the Treasury bills, Treasury bonds, Treasury notes, Mortgage-backed securities issued by government agencies etc. Some of them are also exempt from state and/or local taxes.
Municipal Bond Funds
They invest in securities issued by state and/or local governments for doing public works such as building bridges, laying of state highways, constructing schools etc. Some of them are also exempt from federal taxes. Since they have the backing of the federal government, they are considered to have a very high credit rating.
Corporate Bond Funds
They invest in the debt securities of corporations. They do not have the backing of the government; hence they are a bit more risky than the other two types. However they pay out much higher income than the government funds.
Apart from these funds there are many other types such as the "zero-coupon funds" - that invest only in zero coupon bonds, "international funds" - those that invest in international bonds, "convertible securities funds" - which invest in convertible securities (bonds that can be converted to stock) etc.
