Bond Funds

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How Do Bond Funds Work

A bond fund is a type of mutual fund that invests in bonds instead of stocks. This investment instrument is suitable for individuals who wish to avoid investing in the stock market and for those who prefer to have a steady source of income. Most mutual fund companies offer this type of investment scheme. Here is how it works.

What is a Bond Fund?

This type of mutual fund invests only in bonds. The company that handles bond funds pools money from several investors - big or small - in order to collect one large sum of money. These funds are then used for the purchase of bonds from different sources such as corporations or the authorities.

Bond Funds Investment

A company will have a manager who is in charge of the investments of the fund. His responsibilities include in-depth research on the many different types of bonds as well as the interest rates on a number of them. The manager then chooses which bonds to purchase. In fact, at work is the same process that involves a lender and borrower. The mutual fund company acts as the lender and the corporation or authorities from which the bond is bought stand for the borrower. The government or corporate entity pays the mutual fund on a regular basis, including interest on payments. The mutual fund gains profits in the form of interest that several corporations and the government bodies pay each month. This profit is then distributed equally among the shareholders.

Who Invests in Bond Funds

Anyone can invest in bond funds as long as one has the legal capacity to do so. People who want to invest their hard-earned cash, increasing their monthly income, will find that bond funds come with less risk than stock investments. This is a very popular method of investment among individuals who have retired, but still want to make investments that pay off on a monthly basis. Al the same time, the returns might seem somehow lower as well. In the long run, however, bond funds offer a much more rewarding return on investment than other types of investments instruments.

Types of Bond Funds

There are bond funds that invest only in government bonds, such as the municipal bond fund. This type of bond fund is preferred by the investors because the profit is non-taxable. Other types of bond funds invest in corporate bonds. These can be categorized into investment-grade bonds and junk bonds. Although considered a high risk investment, junk bonds promise greater returns if managed well.

Investment Returns

Investment in stocks comes with greater returns for the investor, but the risk is higher as well. In addition, the returns from bond funds stand at around 4-10 percent of the investment value. For example, if the bond fund has consistently returned at least 8-10 percent in a given year, the investment could double the money for the year. The higher the investment amount, the bigger the return is.