Like bonds, bond funds provide income and
may increase in value. Unlike bonds, however, bond funds don't
pay a fixed rate of interest, have a maturity date, or guarantee
repayment of the amount you invest. This is because each fund
buys and sells bonds of different
terms,
paying different rates, rather than holding its investments to
maturity.
On the plus side, though, you can reinvest
your distributions to buy more shares. And you can invest in a bond
fund for less than you would need to buy bonds on your own —
and get a diversified portfolio to boot.
A fund for every portfolio
Bond funds come in many varieties, with different
investment goals and strategies. You can choose investment-grade
corporate bond funds, long- or short-term U.S. Treasury bond funds,
funds that combine issues with different maturities, or volatile
junk bond
funds often sold under the more promising label of high-yield
funds.
The tax picture
Bond fund income may be taxable or tax free.
Distributions on corporate, U.S. Treasury, and most agency funds
are taxed. But there's no federal tax on municipal bond fund distributions,
and no state or local taxes for investors who live in the municipality
that issues the underlying bonds. Though tax-free funds pay slightly
lower interest rates than taxable funds, they're especially
attractive to people in the higher tax brackets because they may
result in higher actual earnings.
