Bond and bond funds are debt schemes. Bonds are debt instruments that earn fixed income, i.e., generate stable returns for the investors. The investor buys bonds from the bond issuer for a predetermined duration. The bond issuer promises to pay regular interest during the bond tenure. On the other hand, bond funds are mutual funds that invest across various bonds. In other words, a bond fund’s portfolio comprises various bonds with different maturities. Thus the returns largely depend on the type of bonds and prices. This article discusses bond vs bond funds in detail.
What is a Bond Fund?
A bond fund is a type of mutual fund that invests solely in bonds. Bond funds can invest in all of one form of bond (for example, municipal bonds) or a mix of bonds such as corporate bonds, government bonds, etc. Each bond fund is managed to meet a specific investment goal.
Bond funds, like most investments, charge fees and expenses from their investors. These fees can differ significantly from one fund to the other. The asset management company determines the expense ratio and other fees.
Open ended mutual funds are the most common type of bond mutual funds. These funds are actively managed schemes that allow you to buy or sell bond fund units anytime. Thus, you can purchase and sell fund units at their Net Asset Value (NAV). It is the value or price per unit of the fund at the end of each trading day.
Furthermore, returns from bond funds are taxable similar to debt mutual funds. The capital gains are taxable based on the investment holding period. Capital gains are taxable as per your income tax slab rate if the investment holding period is less than three years. While, if the holding period is more than three years, the capital gains attract Long Term Capital Gains (LTCG) tax of 20% with indexation benefit.
Who Should Invest in Bond Funds?
If you are looking for portfolio diversification through debt instruments, bond funds are a suitable option for you. Bond funds invest in a basket of bond securities, thus offering a diversified investment portfolio. Though bond funds are not as risky as equity investments, they do carry a certain level of risk. Thus, you should be well aware of the risks associated with bond fund investments. It is important to note that bond funds do not guarantee principal like individual bond investing.
Therefore, if you are looking for a well-diversified bond portfolio and have a medium to long term tenure, you can consider investing in bond funds.
Recommended Read: Capital Gain Bonds
Bonds vs Bond Funds
Following are the key differences between bond and bond funds:
|Basis of Difference||Bonds||Bond Funds|
|Definition||Companies or government institutions issue bonds for the purpose of raising money. Bonds are issued for a specific duration.||Bond funds are a type of mutual fund that invests in different bonds. The fund portfolio comprises government bonds, corporate bonds, etc. Furthermore, the duration of the bonds may also vary. Thus, bond funds are a diversified investment option that helps you invest across multiple bonds.|
|Maturity Date||Bonds have a set maturity date.||Bond funds do not have any maturity date. The funds constantly buy and sell bonds. Furthermore, the bond fund will disclose the weighted average maturity of the bonds in its portfolio.|
|Returns||Bonds are a type of fixed-income investment. Bonds offer regular income to the bondholder in the form of interest payments.||Bond funds do not guarantee returns. Returns fluctuate depending on the market price of the underlying bonds.|
|Liquidity||Bonds trade on the secondary market after their issue, similar to stocks. However, because the trade quantities are low, bonds are less liquid.||Bond funds are highly liquid. You can exit your investments anytime. However, you should consider the exit load charges before redeeming your investment.|
|Risk||The bond issuer is liable to pay interest to the bondholders regularly. Furthermore, in the event of bankruptcy, bondholders are paid first.||Stock market fluctuations do not directly impact bond funds. However, the interest rates, inflation and other macroeconomic factors impact bond funds.|
|Credit Risk||Bonds with higher ratings are less likely to default.||Bond funds invest across different bonds, and thus the credit risk is diversified. Furthermore, a bond fund’s risk levels depending on the bonds in its portfolio.|
|Portfolio Management||The investor selects, purchases and sells the bonds at their own discretion.||Professional fund managers manage bond funds. After thorough research, these fund managers construct the bond portfolio and make strategic decisions to generate significant returns for the investors.|
|Expense||Investing in bonds incurs no additional costs.||Bond funds have management costs and other fees since professionals manage your investments.|
|Accessibility||Unlike shares, purchasing bonds is not easily accessible to retail investors. Bonds are purchased over the counter. Thus the process is quite tedious for regular investors.||You can easily buy and sell bond funds through an asset management company or online intermediaries and distributors.|