Bonds: The Unbeaten Path to Secure Investment Growth

Chapter 14. BOND FUNDS The Good, the Bad, and the Worst

LET'S FACE IT. The easiest way to invest in bonds is to buy a bond mutual fund. Financial firms have catered to this strategy by creating almost 3,000 such funds and packaging them in a variety of shapes, structures, and contents. But holding an individual bond differs greatly from owning a bond fund because the fund has no due date. "A bond mutual fund is not by definition a fixed-income product," says Cort Smith, senior editor of Investment Adviser.

As we described in chapter 5, fixed-income investments calculate the compounding yield-to-maturity and worst-call yield, referred to as "yield." Funds cannot use those yield calculations so the meaning of the word yield is different when it's applied to them. Fund yields are a good measure of their income-generating potential, more like a current yield for individual bonds.

Although many view competition as a good thing (actually, we do, too), when it comes to funds, it isn't. The tremendous number of funds competing for your attention and dollars has created a severe case of obfuscation. Until 2002, this situation was further compounded by the fact that only 65 percent of a bond fund had to consist of the kind of bonds described in the title of the fund. That changed when the SEC mandated that 80 percent of the securities in a fund must be within the parameters set by the fund name as of July 31, 2002. That still leaves 20 percent of fund assets to be invested either in cash for ...