A bond fund is a collective investment scheme

Collective investment scheme

A collective investment scheme is a way of investing money alongside other investors in order to benefit from the inherent advantages of working as part of a group...

 that invests in bonds

Bond (finance)

In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...

 and other debt securities. Bond funds typically pay periodic dividends that include interest payments on the fund's underlying securities plus periodic realized capital appreciation. Bond funds typically pay higher dividends than CDs

Certificate of deposit

A certificate of Deposit is a time deposit, a financial product commonly offered to consumers in the United States by banks, thrift institutions, and credit unions....

 and money market

Money market

The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit,...

 accounts. Most bond funds pay out dividends more frequently than individual bonds.

Types

Bond Funds can be classified by their primary underlying assets:

• Government/Treasury: Composed primarily of treasury securities
  Treasury security
  A United States Treasury security is government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States federal government, and they are often referred to simply as Treasuries...
  
  , which are the safest debt securities, as they are backed by the full faith and credit of the United States government. Due to the safety, the yields are typically low.

• Mortgage: Mortgage loans issued or guaranteed by government agencies such as the Government National Mortgage Association (Ginnie Mae), Federal Home Loan Mortgage Corp. (Freddie Mac), and Federal National Mortgage Association (Fannie Mae).

• Corporate: Bonds are issued by corporations. All corporate bonds are guaranteed by the borrowing (issuing) company, and the risk depends on the company's ability to pay the loan at maturity. Some bond funds specialize in high-yield securities (junk bonds), which are corporate bonds carrying a higher risk, due to the potential inability of the issuer to repay the bond. Bond funds specializing in junk bonds – also known as "below investment-grade bonds" – pay higher dividends than other bond funds, with the dividend return correlating approximately with the risk.

• Municipal: Bonds issued by state and local governments and agencies are subject to certain tax preferences and are typically exempt from federal taxes. In some cases, these bonds are even exempt from state or local taxes.

Bond funds may also be classified by factors such as type of yield (high income) or term (short, medium, long) or some other specialty such as zero-coupon bonds, international bonds, multisector bonds or convertible bonds.

Advantages over individual bonds

• Management: Fund managers provide dedicated management and save the individual investor from researching issuer creditworthiness, maturity, price, face value, coupon rate, yield, and countless other factors that affect bond investing.
• Diversification: Bond funds invest in many individual bonds, so that even a relatively small investment is diversified—and when an underperforming bond is just one of many bonds in a fund, its negative impact on an investor's overall portfolio is lessened.
• Automatic income reinvestment: In a fund, income from all bonds can be reinvested automatically and consistently added to the value of the fund.
• Liquidity: You can sell shares in a bond fund at any time without regard to bond maturities.

Disadvantages over individual bonds

Although funds do pay dividends, these are not fixed like the interest payments of an actual bond. A fund's dividend may decrease. Similarly, a fund's NAV (share price) may also decrease over time. When buying an individual bond, the investor will get 100% of the bond's face value back at maturity as long as the bond issuer does not default.

Total Return

Price charts on bond funds typically do not reflect their performance due to the lack of yield consideration. To accurately evaluate a bond fund's performance, both the share price and yield must be considered. The combination of these two indicators is known as the Total Return.

See also

• Money fund
  Money fund
  A money market fund is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are widely regarded as being as safe as bank deposits yet providing a higher yield...
  
  
• Income fund
  Income fund
  An income fund is a mutual fund whose goal is to provide an income from investments.Income funds are often assumed to be synonymous with bond funds, however income funds may hold stocks instead , more accurately called equity income funds, or even some combination.The point in any case is that the...
  
  
• Balanced fund
• Target-date fund