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Individual Bonds vs Bond Funds – Which Is Better?

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Introduction

 

When novice investors take a look to invest in the bond market, they have the choice to invest in a variety of fixed incomes assets – with individual bonds and bond funds being the most popular for an investor’s fixed income portfolio. So Individual bonds vs Bond funds – which one will be the perfect fit for your investment needs? In this lesson, I will be covering the important characteristics of each, their respective pros and cons, and whether it may be wise to invest in one or the other – or maybe even both.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Individual Bonds vs. Bond Funds

 

 

Investors commonly purchase bonds as a way to add diversity to their portfolio.

There are two different ways that you can invest in bonds : buying individual bonds and purchasing shares in a bond fund, such as a mutual fund or exchange-traded fund (ETF).

Individual Bonds

 

 

Individual bonds are considered a less risky investment because a bond provides regular interest payments and it returns all of the principal at maturity.

By investing in highly rated individual bonds, an investor can feel confident that the bonds may deliver of these two promises. Of course changes in interest rates can cause a bond’s value to rise or fall but this only matters if you sell your bond before maturity.

If you wait until maturity and rates keep rising, you don’t have to worry since you will still receive your original investment when the bond reaches maturity.

However purchasing individual bonds has its drawbacks.

Some people may not have the funds to purchase a bond because bonds are commonly sold in denominations. A minimum denomination may be as low as $5,000 or as high as $20,000, and this may result in an investor purchasing bonds from only one issuer, leading to a poorly diversified bond portfolio.

 

 

Diversification is as important with bonds as it is with stocks, because purchasing bonds from an issuer means the investor must rely on the issuer’s financial strength in order to reap the benefits of your original investment.

Bond Funds

 

Unlike individual bonds, bond funds allows investors to easily diversify their bond investments because the fund has ownership of several bonds.

A bond fund is an investment that pools money together for many investors to purchase a variety of bonds, with investors buying shares of the fund to receive dividends paid out by the fund.

Investors buy shares of the fund which entitles them to the funds future earnings.

 

 

 

One benefit to bond funds is that buying a share in a bond fund tends to be much cheaper and economically reasonable for money conscious investors – this is also true for a bond ETF. Additionally, a bond fund may provide built-in diversification.

While bonds tend to fluctuate less than stocks, they do fluctuate in value – just like any other financial asset.

A bond fund also doesn’t provide the assurance of consistent interest payments and the return of principal that individual bonds provide.

Despite the inconsistent payments, bond funds do normally pay a dividend. This dividend can vary, but in some cases, it is paid on a monthly basis. So while the amount is inconsistent (you may receive more or less than your previous payout) regular income can generally be expected.

It is true that the bond fund does receive the interest and principal of the bond it owns, but that doesn’t translate to the fund’s shareholder in the same way as it does when owning an individual bond. The fund will receive the principal, and the funds will likely be reinvested or distributed.

Quick Recap

In Review……

Individual Bonds

  • Are a less risky investment because a bond provides regular interest payments and it returns all of the principal at maturity.
  • By investing in highly rated individual bonds, an investor can feel confident that the bonds may deliver of these two promises (regular interest payments and returned principal at maturity).
  • Fixed interest payments are guarnteed
  • If you wait until maturity and rates keep rising, you don’t have to worry since you will still receive your original investment when the bond reaches maturity.
  • Some people may not have the funds to purchase a bond because bonds are commonly sold in denominations – and this may result in an investor purchasing bonds from only one issuer, leading to a poorly diversified bond portfolio.

 

Bond Funds

  • Bond funds allows investors to easily diversify their bond investments because the fund has ownership of several bonds.
  • A bond fund is an investment that pools money together for many investors to purchase a variety of bonds, with investors buying shares of the fund to receive dividends paid out by the fund.
  • One benefit to bond funds is that buying a share in a bond fund tends to be much cheaper and economically reasonable for money conscious investors.
  • Bond funds provide built-in diversification.
  • A bond fund doesn’t provide the assurance of consistent interest payments and the return of principal that individual bonds provide
  • Bond funds pay a dividend to its shareholders. The dividend payments are inconsistent/variable (you may receive more or less than your previous payout) but regular income can generally be expected.
  • Payments tend to be variable yet regular

 

 

As you can see, individual bond provides the promise of regular interest payments and the return of principal at maturity while bond funds usually require low initial investments and provide greater diversification – But choosing to invest in both investments may help reduce the overall volatility to your portfolio and reduce risk.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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