The lowdown on bond funds: should you make them a balanced part of your portfolio mix?
By now, you're probably wondering whether you should buy shares in a bond fund or two. If you already own such shares, you may be wondering whether you ought to hold them, add to them or switch solely to stock funds.
You really need to ask yourself whether any type of debt securities is appropriate for you. Bond funds are simply an indirect way of owning marketable debt securities, which include the U.S. Treasury, a multibillion dollar corporation or your city or school district.
They're all essentially IOU notes, promising to pay a stated rate of interest (known as the coupon rate) at regular intervals, and to repay the principal on a stated maturity date. And they can be bought or sold at any time.
They have fixed face values, called par values, but no fixed market values. As their market values fluctuate with interest rates in the period between their issuance and maturity, so do their yields.
THE REWARDS OF OWNING DEBT SECURITIES
Reliable income flow. You invest in a debt security--bond, note, debenture, or other--primarily to obtain a predictable flow of income that you can rely on for a certain number of years. Frequency of payments--semiannual, quarterly or monthly--may be important, but reliability is crucial. You obtain this by confining yourself to securities issued by governments or corporations that you can expect to maintain interest payments without fail.
Higher income. The level of income in relation to the investment--that is, the yield or return on investment--is normally higher for marketable debt securities than for other financial assets and highest for those having (1) longer maturities or (2) lower credit ratings.
Tax exemption. Income from certain governmental bonds is exempt from certain income taxes. Interest on state and local government bonds is usually exempt from federal tax; it may also be exempt from state and local tax. Interest on U.S. Treasury securities is exempt from state and local taxes (but not from federal tax).
Potential for capital gains. Because prices of outstanding bonds rise when interest rates fall, it is possible that you could sell bonds for more than you paid for them--that is, to realize capital gains instead of holding them to maturity. Opportunities to realize sizable capital gains from the sale of bonds do occur from time to time, but they are not frequent enough to permit you to make long-range plans based on their regular occurrence.
Lower volatility. Bonds do not consistently fluctuate in step with stocks--at times they move in opposite directions--and they tend to be less volatile than stocks over time. Therefore, the allocation of some assets to bonds should make a growth-oriented portfolio less volatile than if it were invested only in stocks.
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|Title Annotation:||excerpted from 'All About Bond Funds: The Complete Guide for Today's Investors'|
|Date:||Sep 1, 1996|
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