[collie1228]

I sent the following question to "Ask Matt" at the USAToday Personal Finance page:

I’ve read several columns and articles on bond funds, and I am not convinced that it is ever a good idea to purchase a bond fund. If I buy shares in a bond fund, the value of my investment may go up or down depending on that fund’s performance in the bond market. I may make money or lose money based on that market. But if I take the same money and buy actual bonds, the worst I can do is get all of my investment back, along with the published interest rate over the period of the bond. Other than default risk, I can’t lose. And better yet, if the prices of bonds go up, I can always sell my bonds at a premium if I wish. Can you come up with an economically sound reason why anyone would rather buy bond funds than the actual bonds?"

Matt's answer to my question was in today's paper, but he really didn't answer my question - in fact he changed the question so he could explain how bond prices work, which I already know. I'm still looking for a good answer to my question - why would anyone buy a bond fund versus buying an actual bond. It seems like a no-brainer to me, but I'm open to be convinced otherwise. Opinions?

[coach]

Your points are well taken. People buy bond funds for different reasons but usually it is for convenience and diversification. They want a check each month and don't have the time or experience to make a selection of a single bond.

[aljetmet]

Originally Posted by collie1228

I sent the following question to "Ask Matt" at the USAToday Personal Finance page:

I’ve read several columns and articles on bond funds, and I am not convinced that it is ever a good idea to purchase a bond fund. If I buy shares in a bond fund, the value of my investment may go up or down depending on that fund’s performance in the bond market. I may make money or lose money based on that market. But if I take the same money and buy actual bonds, the worst I can do is get all of my investment back, along with the published interest rate over the period of the bond. Other than default risk, I can’t lose. And better yet, if the prices of bonds go up, I can always sell my bonds at a premium if I wish. Can you come up with an economically sound reason why anyone would rather buy bond funds than the actual bonds?"

Matt's answer to my question was in today's paper, but he really didn't answer my question - in fact he changed the question so he could explain how bond prices work, which I already know. I'm still looking for a good answer to my question - why would anyone buy a bond fund versus buying an actual bond. It seems like a no-brainer to me, but I'm open to be convinced otherwise. Opinions?

Buying a bond fund or in fact a stock fund protects you from financial disaster if say the company you buy goes belly up say Lehman Bros. or GM
One of the best ways to protect against changes in interest rates is to buy a bond ladder. You buy a bond today with say 10% of the total amount you want to spend on bonds. Then you buy your next bond say 3 to 6 months later. Now depending on the length of the bond, say you buy a bond with 3 years to go, you can go through your cycle and then start all over again. Of course interest rates do change but you will have your basket. You can also do this with CDs but current interst rates do not make this very appealing.
Good luck!

I think the two primary reasons to buy into a bond fund are (1) to spread the credit risk over many issuers, and (2) to have benefit of the services and, hopefully, the wisdom of a professional bond investment manager, such as a Bill Gross. While individual bonds pay off in whole at maturity, they will fluctuate in value during their life cycle as interest rates change, and a possible downgrade in their bond credit rating. So the bond's value is not a certainty prior to its maturity.

Also, some bond funds provide strategies for investing in international bonds (currency exposure), high-yield bonds (more equity like in risk/return) and tax-free income production. The same strategies can be achieved through individual bonds, but with the requirement of more homework for the buyer.

[Taj44]

Also, because the bond fund is making investments on a continual basis, the yield curve of the fund will be smoother than laddered bond holdings of the individual investor. The bond fund will have a much more diversified group of holdings because of its larger pool of investable assets. Bond funds also typically pay significantly lower bid–ask spreads than individual investors i.e. individual investors pay higher transaction costs.

[aljetmet]

Originally Posted by Taj44

Also, because the bond fund is making investments on a continual basis, the yield curve of the fund will be smoother than laddered bond holdings of the individual investor. The bond fund will have a much more diversified group of holdings because of its larger pool of investable assets. Bond funds also typically pay significantly lower bid–ask spreads than individual investors i.e. individual investors pay higher transaction costs.

Absolutely agree, I have several different bond funds. Intermediate some long term some govt. ect. However, with the ladder you know you will have par value when a bond comes due. Interest rates will be going up. When ? who knows but when they do, bond fund values will go down as well as individual bonds. Of course, that's when you want your money. My strategy now is to slowly convert mututal funds to bond funds. I do some every month.

[batman911]

Bond funds generally cannot match the performance of individual government bonds. First you are paying a percentage for management fees and then are forced to sell bonds in an unfavorable environment if investors start pulling money from the fund. You buy a government bond/note at a set price and interest rate and pay no management fees. You can also buy bonds and notes at discounted rates and add to your return. Plus, and this is the biggie, direct purchase of government bonds/note give you insurance by the government that you will not loose principal. That is simply not true of bond funds.

[NJblue]

Originally Posted by batman911

Bond funds generally cannot match the performance of individual government bonds. First you are paying a percentage for management fees and then are forced to sell bonds in an unfavorable environment if investors start pulling money from the fund. You buy a government bond/note at a set price and interest rate and pay no management fees. You can also buy bonds and notes at discounted rates and add to your return. Plus, and this is the biggie, direct purchase of government bonds/note give you insurance by the government that you will not loose principal. That is simply not true of bond funds.

Hmmm. Usually an investor is rewarded for taking additional risk by getting higher returns. Are you saying that no-risk government bonds can beat the interest rates paid by corporate bonds? Doesn't sound right to me.

[collie1228]

No, what I think I'm saying is that investing in a bond fund is a win/lose situation, depending on the bond market. If you buy a government bond directly from the government (i.e., a TIP or a Treasury Bill), you are guaranteed the return of your principal plus the published interest rate. If you invest in a bond mutual fund, you are guaranteed nothing. You may make money or lose money depending upon the bond market. If you own the bond itself, the market means nothing to you. You get your interest and return of your principal when the bond matures. And you can purchase those gov't bonds with no commission. Hmmmm.

[NJblue]

Perhaps if you are comparing short/intermediate term government bonds versus a fund that hold comparable bonds this may make sense. However, I would think that the value of a bond fund comes into play when it invests in higher yielding corporate bonds. Now you are comparing low-risk, but correspondingly low return government bonds with a fund holding higher risk and but higher return corporate bonds. In this type of bond fund, the manager earns his/her expense ratio by selecting bonds with the best risk/reward ratio.

[collie1228]

NJBlue, I agree with you totally. But the value of the bond fund may well be depressed due to factors beyond the selection of the bonds by the fund manager. Interest rates and inflation can raise havoc on bond funds, but buying and holding a bond or a ladder of bonds to maturity pretty much eliminates those risks, especially with government TIFs. I'm looking for protection from inflation and to avoid principal erosion over the next few years. The rates on TIFs are not great, but I'm seeing world problems on the horizon that could have a negative impact on my retirement security, and I don't think bond funds will give me the security that I need.

[cyclone59]

Originally Posted by collie1228

I sent the following question to "Ask Matt" at the USAToday Personal Finance page:

I’ve read several columns and articles on bond funds, and I am not convinced that it is ever a good idea to purchase a bond fund. If I buy shares in a bond fund, the value of my investment may go up or down depending on that fund’s performance in the bond market. I may make money or lose money based on that market. But if I take the same money and buy actual bonds, the worst I can do is get all of my investment back, along with the published interest rate over the period of the bond. Other than default risk, I can’t lose. And better yet, if the prices of bonds go up, I can always sell my bonds at a premium if I wish. Can you come up with an economically sound reason why anyone would rather buy bond funds than the actual bonds?"

Matt's answer to my question was in today's paper, but he really didn't answer my question - in fact he changed the question so he could explain how bond prices work, which I already know. I'm still looking for a good answer to my question - why would anyone buy a bond fund versus buying an actual bond. It seems like a no-brainer to me, but I'm open to be convinced otherwise. Opinions?

with interest rates at there lows and the only way to go is up anyone that buys a bond fund will more likely lose some of their initial purchase vs puting the money into a bond. And yes you are right, the only risk is default. keep in mind that the bond fund has that risk also. So why does everyone put money in bonde funds vs the bond..........Its called broker commission. good luck to you cyclone59

[spalmisciano]

Bond funds make sense when you chose to invest in higher risk securities like high yield[junk bonds] and floating rate bonds.These generate much higher yields than you could get by investing in government bonds but also carry some credit risk. It is because of this credit risk that a fund would make much more sense than trying to buy individual bonds of this type.

[Ragman]

Might want to look at I savings bonds. They aren't paying much of an interest rate, but the inflation adjustment is higher than treasury notes. Plus income is deferred until you wish to cash them and I believe a beneficiary would get the stepped up basis. $ 10,000 per year per person limit.

Wish now I had bought more in the late 90's, early 00's when interest was 2,3,4 % over inflation. Everybody laughed at such a "Grannie" investment, but now they are paying 6 or 7%

[batman911]

Individuals can purchase US government bonds at this website:

TreasuryDirect

Just set up an account and buy what you like. No broker fees.