Bond funds or fixed income funds consist of a basket of bonds. There are many types of bonds, from municipal bonds (cities) to government bonds (US government) to corporate bonds. A bond is a way of borrowing money. When you buy a bond, you are loaning money to some body, a government or corporate body. Your gain is the interest paid on the loan.
Bonds have been popular over time because they are considered one of the safest investments with the interest representing an almost certain return. Governments and other entities use bonds to borrow money for specific projects. A city or county might ask voters to approve a bond for highway work or other infrastructure. If the voters agree, a bond becomes available for investors.
Generally, the interest on a bond will be higher than what you may gain in a savings account or Money Market account. But a bond is more like a Certificate of Deposit (CD) in that you must leave your investment in the bond until the term of the bond ends. In some cases, you can sell your bond before it matures.
In general, the gain from bonds goes up as interest rates go down and vice-versa. Although you are always guaranteed the interest rate of the loan, the value of the loan may change up or down and affect the final gain. You can also lose money in bonds.
Anyone can purchase bonds, from individuals to large corporate investors and bond fund managers. Since a bond is a loan, there is a specific interest rate attached to it. That interest rate determines your gain, minus fees. The loan also has a term, which will determine when you will get your principal and interest.
There are other factors to consider. The income on government and corporate bonds are taxable. Municipal bonds are generally not taxable. When determining your final gain, this could be an important consideration.
Bonds are safe unless the borrower defaults. Even with cities and counties, such defaults do occur. You could also gain less money if a loan is paid off early. If interest rates go up while you are holding your bond, you may lose out on higher return investments. For now, US government bonds are the safest.
Funds of bonds carry similar safety and fairly dependable returns but with more diversity of types of bonds and securities. Most bonds have a term to them, as mentioned above. If you buy bonds on your own, you may get locked into a particular time-frame and will get your returns at the end of that term.
By buying a fund of bonds, various bonds within the fund will mature at different times. Different bonds are maturing fairly frequently giving the fund holder a more steady return without waiting for many years. A bond fund, like any other fund, can be sold at any time so it behaves differently from an individual bond investment.
The diversification of a bond fund can also protect you from bond defaults. The losses are spread out among all investors and many different bond instruments. The losses are not as devastating as having your single bond or small portfolio of bonds default.
On the downside, because bond funds buy and sell bonds frequently, the return may be more volatile. You may get higher or lower returns depending on the bond mix and prevailing interest rates. Because bond funds are managed, like other funds, the fees are somewhat higher.
Finally, bond funds will tend to specialize. Again, these can range from very speculative high-risk high-return bonds to the more stable US government bonds. As with any other investment, you must assess your personal comfort level in terms of risk.
Many investment companies have bond fund offerings. These include well-known and well-established companies like Fidelity, Vanguard, and T. Rowe Price. There are many others. Searching the Internet will give you all the information you need to determine: a) whether a bond fund is right for you and b) which fund best meets your investment needs.
Bonds are a relatively safe and low-risk low-return investment. In the form of a bond fund, both risk and possible return increase.