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Choosing Between Bonds and Bond Funds

by Charles Rotblut, CFA

Choosing Between Bonds And Bond Funds Splash image

Bonds play a role in a portfolio, even when the outlook for interest rates is uncertain. They offer a lower level of volatility than stocks. Plus, bonds have historically had different return characteristics. Determining how to best get exposure to them can be a challenge, however, as there are advantages and disadvantages to choosing between bond funds and individual bonds.

Bond funds offer ease and simplicity. A bond fund gives you instant access to a diversified portfolio of bond holdings. The downside is that the typical bond fund, unlike an actual bond, never matures. The price of a fund’s shares and the cash flows you receive will depend on the bond market’s fluctuations—which are influenced by changes in interest rates—and, of course, the manager’s skill. So, bond funds lack a guaranteed rate of return. Furthermore, with a bond fund you will pay ongoing annual management expenses and have no ability to control the timing of capital gains.

Bonds offer a higher (but not absolute) level of predictability. A bond held to maturity will provide a fixed rate of return. At a pre-specified date, you will get the face (“par”) value of the bond back, typically $1,000 per bond. In addition, you will receive semiannual interest (“coupon”) payments. Both of these amounts are fixed for traditional American bonds and enable you to calculate the pretax rate of return at the time of purchase. This rate of return does not alter as long as you keep the bond to maturity. This is why some bond experts suggest buying actual bonds as opposed to bond funds.

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Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/charlesrotblut.


Discussion

Vince Rappa from New Jersey posted about 1 year ago:

Bonds are a critical part of all portfolios, why don't you recommend a Model Bond Portfolio to compliment your Stock and Fund Portfolios? Right I could use guidance for a 50% Bond Portfolio.


David Flanagan from California posted about 1 year ago:

Messege for Mr. Rotblut;

I am considering placing my investment portfolio into the Shadow Portfolio. I would
like your opinion on whether to start one
now are wait till after the new year (because
of the fiscal cliff)?
I am retired and would like to know the
least number of years you would recommend
if investing the the Shadow portfolio?
If starting with 15 stocks, do you folks
have any recommendations on which stock to
buy first?
Will appreciate you information and guidance.
Dave Flanagan
daveflanagan3@gmail.com


Gerald Weinkam from Ohio posted about 1 year ago:

The problem I have trying to buy individual bonds is knowing what a fair price is for the bond.


R Speir from Florida posted about 1 year ago:

Model bond portfolio is a good idea.


H Mc allister from Arkansas posted about 1 year ago:

There are so many different types of bond funds,ie;emerging mkts, short, intermediate, long term, intn'l,inflation protected, etc, that I would think it very difficult to create a model bond fund portfolio due to different investors age groups and investment objectives.


Joseph Bellanca from Illinois posted about 1 year ago:

i have a50% allocation in my portfolio , I had my broker help me ladder a portfolio of different and dates.


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