Reviewed by Sep 30, 2020| Updated on
A bond fund invests primarily in bonds and other debt instruments with investments in sectors such as government, corporate, municipal, convertible bonds, and in debt securities such as mortgage-backed securities.
Bond funds provide instant diversification as it requires a low minimum investment. Interest rate and bond prices are inversely proportional to each other, i.e. a long-term bond has higher interest rate risk than a short-term bond.
A bond-fund, also known as debt fund, is simply a mutual fund that only invests in bonds. It can be a more efficient way of investing in bonds than to purchase individual bond securities. They have a maturity date for repaying principal. The interest payment must be made on a monthly basis.
Additionally, investors indirectly participate in the interest paid by the underlying bond securities held in the mutual fund. Interest payments are made every month and illustrate a mix of the different bonds in the fund. That means the interest income distribution will vary on a monthly basis.
An investor who invests in a bond fund puts the funds into a pool managed by a portfolio manager. Typically, a bond fund manager buys and sells bonds according to market conditions; he rarely holds bonds until maturity.
Bond funds comprise of either government funds or corporate funds with a predefined time for maturity. Some bond funds invest only on safe bonds but offer the lowest potential return. On the other hand, some bonds invest in the riskiest category and yield high returns or junk bonds. You can also see the variant where investment is made on different types of bonds to create multi-asset class options.
Bond funds that invest in more volatile bonds tend to potentially offer higher returns. Still, other bond funds have a mix of different types of bonds in order to create multi-asset class options.