How to Retire Happy by Stan Hinden

Author:Stan Hinden
Language: eng
Format: epub
Publisher: McGraw-Hill Education
Published: 2013-04-06T04:00:00+00:00

MULTISECTOR BOND MUTUAL FUND

Bonds are loans, typically made by investors to governments or corporations. Investors receive interest payments, usually every six months, and get their original principal back upon maturity. Mutual fund managers often buy and sell bonds and will have bonds with different interest rates and maturities in their funds. A fund’s rate, then, is a blend of the rates on all the bonds in the portfolio.

When bonds are sold initially, they are given credit ratings that reflect the financial soundness of the government agency or business that issues them. The highest rating is AAA. Any bond rated between AAA and BBB is considered an investment-grade bond. Anything below BBB is often referred to as a “junk bond.”

The global bond market is enormous and complex, much larger than the global stock market. Bonds are issued by governments, municipalities, and corporations and can vary widely in credit quality, time to maturity, and other criteria. More important, unlike the situation with stocks, where it is easy to find the exact price and there are indexes such as the Dow Jones Industrial Average or the Standard & Poor’s 500 that indicate how the market overall is doing, bond prices are not that easy to find. In many cases, bond prices are not even fixed, but negotiated.

Until recent years, most sovereign (government) bonds were of the highest quality. However, this began to change when European countries began to experience economic problems. In the case of Greece, in the spring of 2012, the country had essentially defaulted on roughly 74 percent of its government and foreign-law bonds, according to Fitch Ratings. In the United States, mounting federal debt loads prompted a Standard & Poor’s credit downgrade in the summer of 2011. There are now more AAA corporate bonds than AAA sovereign bonds. Not surprisingly, companies with lower credit ratings pay a higher interest rate on their bonds than do companies with higher credit ratings. Those higher interest payments are what make junk bonds so attractive to investors. However, investors in high-yield bonds face the “business risk” that a company might not be able to pay the interest on its bonds. The advantage of using mutual funds is that fund managers have analysts who review the bonds before the fund purchases them. Also, the fund managers can get better prices for bonds than individuals can get on their own, partly as a result of buying in volume. In addition, most bond funds pay out on a monthly basis and thus are ideal for providing retirement income.

All bond funds are subject to certain risks, especially the movement of interest rates. When interest rates rise, the value of a bond will decline—and vice versa. In the summer of 2012, because of an ongoing flight to quality resulting from uncertainty around the euro, government bonds rose in price and many were selling at premiums to face value, thus producing historically low yields. The 10-year Treasury bond dropped to a yield of 1.42 percent.

The primary goal of many bond funds is to produce income.

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