Bondsonline: Bond Funds vs. Bonds

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WHAT IS THE DIFFERENCE BETWEEN INVESTING IN BOND FUNDS VERSUS INDIVIDUAL BONDS?

This gets asked a lot. The table may help to compare these with Unit Investment Trusts.

	Bond Mutual Funds	Bond Unit Investment Trusts	Individual Bonds
Pros	diversification; professional management; liquid	diversification; fixed maturity; fixed interest income	higher yields; fixed maturity dates
Cons	more expensive: higher costs mean lower yields;no fixed maturity date	not as liquid as mutual funds; higher sales charge than individual bonds	not as liquid as funds;investor must manage
Brief Definition	managed portfolio of bonds	fixed portfolio of bonds held in a trust	individual securities
Maturity Date	no date - bonds are constantly bought and sold	trust buys a set of bonds with fixed maturities	set maturity date. Choice of 1 - 30 years.
Income Payments	fluctuating monthly payments	investors choice: fixed monthly, quarterly, or semiannual payments	semiannual, except zero coupon bonds
Liquidity	sell anytime at current fund value	sell anytime at current market price.Less liquid than funds	sell anytime at current market price. some bonds less liquid.
Diversification	constantly changing portfolio	fixed diversity of investments	individual chooses from multiple issues
Management	professional	monitored, not managed	investor managed
Costs	annual management; may have a load	sales charge at purchase; annual fee	one time charge at purchase or sale
Minimum Investment	varies among funds	often $1,000	usually $5,000 and increments of $5,000
Reinvestment	dividends can be reinvested	some trusts alow reinvestment	investor must do it.
Availability	always available	can be limited by trust	limited by issue

Bond Mutual Funds

Mutual funds pool together capital from many investors who share similar investment goals. Bond mutual funds can invest in any type of fixed income security except CDs. The major categories of fixed income mutual funds include:

Taxable Bond Funds. These offer a wide range of choices depending on your investment objectives. Some invest in corporate securities, some in US Government securities; some invest in high-risk, high income securities, and some invest in low-risk, lower income securities.
Tax-Free Bond Funds. Federal tax exempt bond funds seek to provide high after tax income and invest in a variety of municipal bonds issued within a number of different states. State-specific funds invest in bonds issued only within one state to obtain current income that is exempt from federal and state, and sometimes local, income tax.
Taxable and Tax-Free Money Market Funds. These provide current income while seeking to maintain a constant share price.

Unit Investment Trusts ( UIT )

A UIT is a package of income producing securities that is purchased and held in a trust until the final amount is paid. UITs invest in a wide range of issues, from Treasury to corporate to municipal bonds, and once the portfolio is assembled, the securities are monitored, but not actively managed.

UITs charge an annual fee that is deducted from the yield, and pay an initial sales charge to the sales representative. Sales charges may range from 3.5 to 5%. UITs are offered on a "dollar price" basis, with the return expressed in terms of estimated current return (net interest income divided by public offering price).

Individual Bonds

You can buy individual bonds for your portfolio similar to how you buy stocks. Unlike stocks, however, availability and the prices of bonds vary from dealer to dealer.. Large bond dealers maintain an inventory of bonds which may not be available through other dealers.

Bonds are generally offered on the basis of yield to maturity, which can be hard to follow and compare. While some yields are quoted in financial pages of newspapers, these represent yields for only a small fraction of the available bonds, and represent rates that apply to institutional-size trades. From the yield to maturity, bond prices are calculated, and quoted as a bid price (the price at which you sell) and the offer price (the price at which you buy). Generally, you can expect to get better prices as the size of the order goes up.

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