How to Invest In Bond Funds

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how to invest in bond funds
While you can purchase individual bonds issued by the federal government, state municipalities, and corporations, the least risky way to do it is through mutual funds. Using this approach, you’re relying on a bond expert to select and manage a large portfolio of many bonds that match your investment risk tolerance level. So in this article, I’m going to show you the basics of how to invest in bond funds.

Mutual Funds
Ninja Training Guide

  1. Introduction: 8 Advantages of Investing In Mutual Funds
  2. 3 Ways Mutual Funds Make Money for Investors
  3. The Truth About Mutual Fund Fees and Expenses
  4. Which Mutual Funds to Choose and When: The Money Shifting Strategy
  5. How to Invest in Stock Funds
  6. How to Invest In Bond Funds
  7. How to Invest In Money Market Funds & Conclusion

 

This should be enough to provide a foundation on which you can make smart investment decisions.

But before I get to the walkthrough, there are a couple of things to keep in mind.

1. The trading activity of bond mutual funds is not nearly as robust as stock mutual funds, but buying and selling activity occurs on a daily basis.

2. Bond funds make money is two primary ways. First, the bonds within the fund pay interest that is either distributed to the mutual fund investors or reinvested back into the mutual fund to buy more bonds.

Second, if the mutual fund manager finds great deals on bonds through new money that flows in plus amounts you reinvest, this can cause the overall value of the mutual fund to rise. This will then translate into your shares being worth more. I’ll get deeper into this area shortly.

Now, let’s examine a specific example.

Bond Fund Profile – Overview & Summary

In the first image below, I logged into my online brokerage account and captured information for a typical corporate bond mutual fund. In this case, the mutual fund family/company is Invesco. Its trading symbol is ACCHX. Please note that I am not suggesting that you invest in this fund. It was a random choice.

As you can see, just below and to the left of the bond fund name, there is the symbol and words “NL No Load”. Mutual funds with this designation are the most recommended type because it means you don’t have to pay a silly sales commission to buy into it.

mutual fund bond fund

The next important element in the image is the price that you would pay to get into this bond fund. It’s very different than purchasing an individual bond.

See where it says $7.05. This “share price” is frequently referred to as the Net Asset Value.

It is calculated by taking the total net assets of the mutual fund and dividing it by the total number of outstanding shares. So for this fund, there are 128,936,170 shares outstanding. Basically, I just divided total net assets of $909M by $7.05.

So, you would pay $7.05 per share to invest in this fund. Now, for most bond funds you will also be required to invest a minimum dollar amount. This one is set to $1,000 or more. That will buy you 141.84 shares ($1,000 divided by $7.05). But remember the nature of mutual funds. Each share represents a tiny ownership in each and every bond held in the fund.

Next, you should notice a chart with two squiggly lines for the bond fund that track its performance over the last 3 years. If you scan the “green” return on investment line from left to right, it looks like the fund has gone from a nearly zero return on investment to almost 20% over this timeframe.

The “orange” line represents the overall performance of the stock market for the same period of time. As you know, historically it’s not unusual for stocks to kick the pants off bonds, performance-wise. But the chart just let’s you know by how much the two differ.

So your likely question for this mutual fund is, “Is the performance for this fund good or bad?”

The answer is, you won’t know until you compare its performance to other similar bond funds. You have to do your homework.

To the right of the chart, you should see the Gross and Net Expense Ratios. These percentages represent the expenses associated with operating the fund (e.g., administrative, research, etc.). Since bond funds are less active than stock funds, these percentages are usually less than 1%. But the lower they are the better because this is money that comes out of your pocket.

For example, if the fund has $1 billion in net assets, and the expense ratio is 1%, that amounts to $10 million coming out of the investors’ pockets.

Next, below the ratios, you’ll find the “SEC 30 Day Yield” and the “Distribution Yield”. The SEC 30 Day yield represents the current average of what each bond within the fund would earn in interest and dividends if you held them until they matured.

It’s a good way to look at what’s going on inside the bond fund. It also gives you a good idea of what the fund could earn going forward. Compare it against the yields of other bond funds to gain insight into their future direction.

The Distribution yield is less reliable than the SEC yield. That’s because it projects how the bond will perform over the next year based on how much it earned in one recent month. This is different from the SEC yield which is based on the actual terms of each bond.

Bond Fund – Asset Allocation

As you can see in the chart below, our example Invesco bond fund consists of 759 different bond holdings, which account for 95.27% of the entire portfolio.

About 82% of the bonds are corporate, with the rest being Treasury bonds, mortgage-backed securities, municipal bonds, and cash.

bond fund holdings

 

Bond Fund – Morningstar Wrap-Up

Next, the image below shows Morningstar’s risk profile for our example Invesco corporate bond. This information is provided along with the above chart. And if you’re not familiar with Morningstar.com, they are a popular company that evaluates and rates mutual funds, and a whole lot more.

bond fund risk profile

In any event, the Morningstar Style Box provides an indication of the general “quality” of the bonds held by the mutual fund and the “maturity” timeframe for most of the bonds. The shadowed box in the lower right corner of the Style Box means that most of the bonds in this fund are considered to be “Low” quality and “Long” term in nature (4 or more year to maturity).

The “Risk” indicator for the fund is set to “Average” and the “Return” indicator is set to “Above Average”.

So what we have here is a mutual fund that is comprised of low quality, high-yield, corporate bonds, with average investment risk, and potentially above average earnings.

As I mentioned above, you won’t know if it’s a winner until you compare it to similar funds. And keep in mind that “Average” risk is not the same as risk-free.

Bond Performance Profile

I’ve already covered a lot of what you should know about the performance of this bond fund. But in the chart below, you can view the fund’s return on investment for the last 5 years. See the row that says “ACCHX Market Return”? In 2013, it’s rate of return was a measly .37%.

bond fund return on investment

The next row on the chart is labeled as “+/- Corporate Bond”. This tells you how well this fund is performing against the broader category of all similar corporate bond funds. In this example for 2013, the green percentage means that the the Invesco bond is performing 1.08% better than the category as a whole.

The third row labeled as “+/- Barclays US Agg Bond TR USD” tells you how our Invesco bond stacks up against the general bond market. So the Invesco bond is performing 1.46% better than the broader bond market index.

Finally, the Invesco bond has a “Rank in Category” of 17, meaning that there are 16 similar corporate bonds that are ranked higher.

Whew! So now you know how to invest in bond funds. In most cases, you can purchase mutual funds shares directly through your online account. And if you don’t have an account, you can contact the mutual fund company directly.

But the key to investing in bond mutual funds is to research and compare. Also know your risk level and investment timeframe. Finding a fund that you like is not difficult. It just takes a little time.

>>>How to Invest in Money Market Funds & Conclusion>>>

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