Investing in bond funds can be much easier and more cost effective than investing in individual bonds. And, almost every investor can benefit from a bond fund component in his or her portfolio.
Prepare to talk with your financial advisor about bond fund investing by reviewing these important subjects:
And, if you'd like to know more about the underlying investments in bond funds - the bonds themselves - brush up on How Bonds Work.
Enjoy bond fund benefits
Like individual bonds, bond funds can offer investors key benefits:
- Relative stability to help balance the relative volatility of stocks and stock funds.
- Current income from interest payments.
- Tax advantages. For individuals in higher tax brackets who are investing outside tax-deferred retirement accounts, municipal funds can be a smart investment. They provide federal-tax-free (and in some cases state-and-municipality-tax-free) income. Calvert offers five tax-free options, including four bond funds and one money market fund.
In addition to these benefits, bond funds offer significant advantages over individual bonds:
- Professional management
Fund managers have the experience, expertise, and technology for research and evaluation unavailable to most individual investors. They understand the complex interactions of issuer creditworthiness, maturity, price, face value, coupon rate, yield, and countless other factors that affect bond investing. Calvert's fixed income managers receive frequent press coverage, have years of expertise in varying market conditions, and are well known in the industry.
- Diversification
A bond mutual fund invests in many individual bonds, so even a relatively small investment is diversified - and when an underperforming bond is just one of many bonds in a fund, its drag on an investor's overall portfolio is lessened. It would require considerably more money for an individual-bond investor to achieve the kind of diversification possible in one share of a bond mutual fund.
- Automatic income reinvestment
In a fund, income from all bonds held is automatically and consistently added to the value of the fund.
- Liquidity
You can sell shares in a bond fund any time during market hours. However, it's important to note that share values are determined when the market closes, typically at 4 pm Eastern Standard Time. While it's possible to sell individual bonds prior to maturity, the price is not guaranteed.
Understand bond fund risks
Bond funds involve less risk than individual bond funds because they're diversified, investing in many individual securities. However, like all investments, bond funds involve some degree of risk. You'll want to talk with your financial advisor to understand more fully both the potential advantages and potential risks of bond fund investing. Use this discussion to help formulate questions for your advisor.
- Interest rates
When interest rates rise, bond prices usually fall. And, when interest rates fall, bond prices usually rise. Accordingly, bond prices are affected by market conditions and interest-rate fluctuations. However, market risk is diminished somewhat for holders of bond funds as compared with holders of individual bonds, but it can influence the value of a bond fund investment. Learn more about interest rates and bond investing.
- Inflation risk (loss of purchasing power)
A high rate of inflation can reduce the purchasing power of income from a bond fund investment. For this reason, investors who have a long time horizon before needing to use income from their portfolio generally direct a small portion of their investment to bond funds and a larger portion to stock funds. Then, as the time to depend on the portfolio's income stream approaches, the investment to bond funds may increase. Learn more.
- Credit risk
Bond issuers vary in their creditworthiness, since issuers differ in their perceived ability to repay a loan at maturity and to pay interest.
Two of the best-known independent credit rating services are Moody's and Standard and Poor's. They assign ratings that indicate relative creditworthiness:
|
Moody's |
Standard & Poor's |
| Highest quality |
Aaa |
AAA |
| High quality |
Aa |
AA |
| Higher medium quality |
A-1, A |
A |
| Medium quality |
Baa-1, Baa |
BBB |
| Speculative quality |
Ba |
BB |
| Highly speculative quality |
B,Caa |
B, CCC, CC |
| Default |
Ca, C |
D |
"Investment-grade" bonds are generally medium quality (Baa-1, Baa, BBB) or above. "Junk" bonds are generally lower than medium quality. For bond funds, which invest in many different bonds, you can review the average credit quality of the portfolio and view the percentage of the portfolio that's invested in each quality level.
Be sure to talk with your financial advisor about how to balance the potential risks and benefits of bond fund investing in your own situation.
Interest rates and bond fund investing
The relationship between interest rates and bond fund performance is sometimes over-simplified in media sound bites about investment markets. We hear gloom-and-doom predictions for bond investors when rates begin to rise.
Of course, bond funds are not stable value investments and involve risk. Their value is affected by changes in the direction of interest rates. As interest rates rise, bond prices decline, and vice versa. But in reality, both rising and falling interest rates can offer advantages to bond investors:
- When rates rise, bond prices can be expected to fall, yet higher rates can mean higher returns on reinvested bond income.
- When rates fall, bond prices can be expected to rise, potentially boosting a fund's return.
What's the practical application? How should interest rates affect your bond-fund investment decisions? You'll want to talk with your financial advisor about your own situation, but in general what's true in stock investing is true in bond investing as well:
- You make portfolio decisions based on your goals, your attitudes about investment risk, and the time until you'll need to begin using money from your investment.
And, if rising rates are a concern for you, remember that a bond fund's duration (essentially, the average time to maturity of all its holdings) can suggest how interest rates might affect performance. The longer the fund's duration, the more susceptible it is in the short term to rising rates. For example, if rates rise 1%:
- A fund with a 3-year duration might be expected to lose about 3% of its value.
- A fund with a 10-year duration, however, might be expected to lose about 10% of its value.
Bond funds can play an important role because they help diversify your portfolio and produce investment income. Calvert offers a full line up of taxable and tax-exempt bond and money market funds with durations appropriate for a variety of market conditions. You can use them to help weather the ups and downs of the market.
A word about money market funds
Maintaining a savings fund for emergencies. Saving to buy a home within the next five years. Preparing for your child's freshman year in college. They're all times when you might want to earn a higher level of current income than you can expect from a traditional savings account - but you don't want to expose your money to market fluctuations.
Money market mutual funds can be an appropriate investment for these and other goals. The funds seek to maintain a consistent net asset value of $1.00 per share by investing in short-term corporate and government debt. Although the investment is not insured by the FDIC, these funds give you immediate access to your money, check-writing privileges, and other conveniences.
Calvert offers three different money market mutual funds, including a tax-advantaged option.
Talk with your financial advisor today about which Calvert fixed-income investments may be best suited to your needs and overall investment profile. If you don't have a financial advisor, use our free Advisor FinderTM Service to locate a qualified investment professional in your area. You can also contact our Sales Department at 800.368.2748.
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