Bond Funds
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TO UNDERSTAND how bond funds work, you should really visit our Bonds section. But we'll touch on them here. Bond funds are designed to give your portfolio its recommended dose of fixed income so you don't have to go through the hassle of buying bonds yourself. These, too, come in various types. Term Funds
All bonds are structured so that you get paid your principal after a set amount of time. They're either short, intermediate or long term, depending on the number of years until they mature. Bond funds are the same way. A fund like Dreyfus Premier Short Term Income is typical of its class, buying a mixture of corporate and government bonds with durations of less than three years. Intermediate funds like Liberty Intermediate range between three and 10 years, while Vanguard Long-Term Corporate typically only buys bonds with maturities greater than six years. Generally speaking, the longer the duration, the higher the risk and reward. Why? Because the longer you hold a bond before it matures, the greater the chance its value could be adversely affected by inflation. As a result, whatever company or government issued the bond has to promise a higher yield upfront.
Municipal-Bond Funds
Muni-bond funds invest in bonds issued by state municipalities. Some funds, like Eaton Vance National Municipal, invest in bonds offered throughout the country. Others, like the Pimco New York Municipal Bond fund, invest in one state only. Tax breaks are the big draw of muni-bond funds. If you own a national fund, you're exempt from federal income taxes on any income you receive from the fund. If you live in the state specified in a state-specific fund, you are exempt from state and federal taxes. However, your lower taxes generally come with lower returns. Only investors in high tax brackets should buy these funds. Government-Bond Funds
Investors who are concerned about credit quality may want to consider a government bond fund. These funds hold bonds that are backed by the full faith and credit of the U.S. government. Government-bond funds come in varying durations, from short-term to long-term. They also can vary in terms of the investments they hold. Some funds invest almost exclusively in U.S. Treasurys, while others branch out into government agency debt like Fannie Mae bonds and Federal Home Loan Bank bonds. High-Yield-Bond Funds
Bond funds invest in different grades of corporate bonds. High-yield, or "junk-bond," funds are the most well-known of the bunch, because they offer the highest rates. Unfortunately, since these funds invest in low-grade corporate issues, they also entail the greatest risk. Companies with credit ratings of BBB or less are the most likely to default on their coupon payments. In another words, although the income may be high on a fund like Fidelity High Income, it's not guaranteed. Only the most risk-tolerant investors need apply. Data as of Dec. 31, 2003
Source: Morningstar
TO UNDERSTAND how bond funds work, you should really visit our Bonds section. But we'll touch on them here. Bond funds are designed to give your portfolio its recommended dose of fixed income so you don't have to go through the hassle of buying bonds yourself. These, too, come in various types. Term Funds All bonds are structured so that you get paid your principal after a set amount of time. They're either short, intermediate or long term, depending on the number of years until they mature. Bond funds are the same way. A fund like Dreyfus Premier Short Term Income is typical of its class, buying a mixture of corporate and government bonds with durations of less than three years. Intermediate funds like Liberty Intermediate range between three and 10 years, while Vanguard Long-Term Corporate typically only buys bonds with maturities greater than six years. Generally speaking, the longer the duration, the higher the risk and reward. Why? Because the longer you hold a bond before it matures, the greater the chance its value could be adversely affected by inflation. As a result, whatever company or government issued the bond has to promise a higher yield upfront.
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Muni-bond funds invest in bonds issued by state municipalities. Some funds, like Eaton Vance National Municipal, invest in bonds offered throughout the country. Others, like the Pimco New York Municipal Bond fund, invest in one state only. Tax breaks are the big draw of muni-bond funds. If you own a national fund, you're exempt from federal income taxes on any income you receive from the fund. If you live in the state specified in a state-specific fund, you are exempt from state and federal taxes. However, your lower taxes generally come with lower returns. Only investors in high tax brackets should buy these funds. Government-Bond Funds
Investors who are concerned about credit quality may want to consider a government bond fund. These funds hold bonds that are backed by the full faith and credit of the U.S. government. Government-bond funds come in varying durations, from short-term to long-term. They also can vary in terms of the investments they hold. Some funds invest almost exclusively in U.S. Treasurys, while others branch out into government agency debt like Fannie Mae bonds and Federal Home Loan Bank bonds. High-Yield-Bond Funds
Bond funds invest in different grades of corporate bonds. High-yield, or "junk-bond," funds are the most well-known of the bunch, because they offer the highest rates. Unfortunately, since these funds invest in low-grade corporate issues, they also entail the greatest risk. Companies with credit ratings of BBB or less are the most likely to default on their coupon payments. In another words, although the income may be high on a fund like Fidelity High Income, it's not guaranteed. Only the most risk-tolerant investors need apply. Data as of Dec. 31, 2003
Source: Morningstar
