Bond Funds: How to find and choose them

A bond fund invests in bonds or debt securities. It pays dividends including interest on the fund’s underlying securities plus realized capital appreciation. Now that you’re up to speed on treasury bonds, let’s take a look at bond funds and how they work.

What is a bond fund?

A bond fund is a fund invested primarily in bonds and other debt instruments. The exact type of debt in which the fund invests will vary, but investments may include government, corporate and municipal bonds, along with other debt securities. Most bond funds pay out dividends more frequently than individual bonds.

How do bond funds work?

A bond fund represents a collection of securities. The investor pays the mutual fund company an annual fee and sometimes a sales charge (called a load) to buy the fund. In exchange, the mutual fund company offers the investor an instant portfolio with professional management. The interest investors receive from the fund is a portion of the total interest received by all the bonds minus management fees that are taken out.

Most bond funds are open-end funds – meaning that there is no limit for the number of shares available. As more people buy into the fund, more bonds are purchased. The mutual fund shares then sell at a price that directly reflects the price of all the bonds held by the mutual fund.

Most funds are actively managed, which means that the managers try to beat the broad bond market by picking certain issues of bonds or by trying to time the markets. Other mutual funds are passively run, which means they are set up to track standard fixed-income indexes. Index funds tend to cost significantly less in fees than actively managed funds.

Different Types of Bond Funds

Bond funds can be classified by their primary underlying assets

  • Government: Since a government can always print more money to pay its debt, government bonds are typically the safest. Due to the safety, the yields are typically low.
  • Municipal: Municipal bonds are issued by state and local governments are subject to certain tax preferences and are typically exempt from federal taxes. In some cases, these bonds are even exempt from state or local taxes.
  • Corporate: Bonds issued by corporations, whereby the risk depends on the company’s ability to pay the loan at maturity. All corporate bonds are guaranteed by the borrowing (issuing) company. Some bond funds specialize in high-yield securities (junk bonds), which are corporate bonds carrying a higher risk. This is due to the potential inability of the issuer to repay the bond. Bond funds specializing in junk bonds pay higher dividends than other bond funds, with the dividend return correlating approximately with the risk.

Bond funds can also be classified by factors such as type of yield or term. They can even be classified by specialty such as international bonds, zero-coupon bonds, convertible bonds, etc.

Advantages of bond funds

  • Management
  • Diversification
  • Automatic income reinvestment
  • Liquidity

Disadvantages of bond funds

  • Fees
  • Variable Dividends
  • Variable Net Asset Value (NAV)

There’s a whole lot to learn about bonds, and we really only scratched the surface. If you’re interested in learning more about investing in bond funds, check out our Investing in Different Markets course.


The Best Stock Newsletters as of January 3, 2025

Ranking of Top Stock Newsletters Based on Last 3 Years of Stock Picks

We are paid subscribers to dozens of stock and option newsletters. We actively track every recommendation from all of these services, calculate performance, and share our results of the top performing stock newsletters whose subscriptions fees are under $500. The main metric to look for is "Excess Return" which is their return above that of the S&P500. So, based on January 3, 2025 prices:

RankStock NewsletterStock
Picks
Average
Return
S&P500
Return
Excess
Return
Percent
Profitable
Max %
Return
Min %
Return
1.Seeking Alpha logo
Alpha Picks
6471.7%23.9%47.8%77%969%-47%
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Save $50
2.Zacks logo tiny
Value Investor
3926.8%13.9%12.8%51%494%-41%
Summary: 10-25 stock picks per year based on Zacks' Quant Rating; Retail Price is $495/yr. Read our Zacks Review.FEBRUARY PROMOTION:$1, then $495/yr
3.Zacks logo tiny
Top 10
3321.2%8.4%12.8%52%170%-56%
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4.Moby logo tiny
Moby.co
31142.1%31.4%10.7%74%1030%-95%
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5.Motley Fool logo
Stock Advisor Canada
3631.8%25.3%6.5%81%216%-68%
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6.Motley Fool logo
Hidden Gems
7638.1%32.9%5.2%71%258%-100%
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Read our Epic Review.
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7.TheStreet logo
Action Alerts Plus
37820.8%16.7%4.1%56%220%-77%
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8.TipRanks logo
TipRanks SmartInvestor
12410.3%7.2%3.1%60%269%-48%
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9.Motley Fool logo
Rule Breakers
6636.2%35.4%0.8%65%344%-81%
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10.Motley Fool logo
Stock Advisor Canada
7125.2%24.8%0.5%73%216%-93%
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Top Ranking Stock Newsletters based on their 2024, 2023, 2022 stock picks' performance as compared to S&P500. S&P500's return is based on average return of S&P500 from date each stock pick is released. NOTE: To get these results you must buy equal dollar amounts of each pick on the date the stock pick is released. Investor Business Daily Top 50 based on performance of FFTY ETF. Performance as of January 3, 2025.

Build your wealth faster with best stock picks: See our current ranking of the BEST STOCK NEWSLETTERS.