Thursday, June 3, 2010

Investment: Bond Fund

Bonds are debt instruments. For example, if I need money from you, you can pass your money to me and I will give you a piece of paper saying that I owe you this amount of money. I may or may not pay you any interest amount. After a period of time, I will return the money to you hopefully if luck is on your side. In real life, things are more complicated and you cannot really get people to lend you money without convincing them that you can repay the principal amount in the future. In addition, you will need to pay them interest amount if you ever hope that they will part their money willingly with you. There are also other factors to consider including your credit rating, bond valuation, etc.



How do we invest in bonds? You can either get it through a broker (this usually involves $100k and above) or you can invest in treasury bills through banks or security firms. There is very little fee (if any) involved in these transactions. Treasury bills are safer in nature because they have shorter maturity and they are guaranteed by our government. Notwithstanding there are factors such as callability, duration and so on, most highly rated bonds are generally safer than stocks. However, no risk no gain. Bonds' return are very pathetic ranging from less than 0.5% for treasury bills onwards.



If you have been following the development in the European Union these days, you will know that bonds are still subjected to certain level of risks. The companies or countries selling you the bonds could go bust. If you are forced to liquidate the bonds during a crisis, you may even lose your principal sum.



With such low return and the fact that bond investment is not risk-free, does it make sense to invest in funds of bonds? Of course, not. Bond funds are basically mutual funds that invest in bonds and the fund managers earn a cut from the return. So, if the return of the bond fund is 5% (interest payment and capital gain) and you have to pay 3% for management and administrative fees, you will earn only 2% after deduction. In addition, you have to bear the risk of investing in these bonds.



Therefore, if you ever want to invest in bonds, try not to invest in bond funds because you will never get anywhere with it. And, if you really must invest in bonds to diversify your portfolio, the best strategy is to make direct investment within your limits.



Happy investing.

Disclaimer: The content in this blog contains purely my personal opinion and it is in no way a substitute for professional financial advice. You should seek advice from a professional financial advisor with any question regarding your financial matters.

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