Bond mutual funds are pools of investment capital overseen by professional money managers. These portfolio managers invest on behalf of investors, often exclusively in bonds, which are instruments that pay a fixed rate of return to investors over time. Bond mutual funds are conservative investments that expose investors to minimal risk. Returns tend to be modest but dependable. A mutual fund portfolio manager might invest in regional government bonds as well as corporate debt, and sometimes will even invest in equities to bolster returns.
Bonds are a form of debt issued either by a regional government or a company that trades in the fixed-income market. They are loans extended by investors to the issuer. In exchange for the loan, the issuer must pay the lender ongoing interest payments, known as the coupon, at an interest rate that is established at the beginning of the contract.
Coupon payments are made through the expiration, or maturity date. When the bond expires, the issuer pays the lender the principal amount of the loan. A bond's price is determined by the interest rate and the financial condition of the issuer.
By investing in bond mutual funds, investors gain greater diversity than they would be able to achieve by investing in individual bonds. Bond fund managers combine capital from investors and spread it across multiple fixed-income assets that fit the risk and reward objectives of the fund. Although bond mutual funds require a minimum investment, that amount typically is lower than for some large individual bonds. Mutual fund fees are tied to performance and management.
It is the job of the fund manager to create and preserve wealth for investors in exchange for certain fees. A bond mutual fund manager is not expected to generate blockbuster returns that might be a goal in an equity portfolio. This is because with bonds, the risk exposure is minimal. In order to create a balanced portfolio, some bond mutual fund investors diversify by allocating a portion of investment capital to equity exposure, which by nature introduces more risk but carries promise for greater returns.
There are various types of bonds that a mutual fund manager might invest in, and while these are inherently safer investments than equities, some carry more risk than others. Among them, high-yield or junk bonds are among the most risky. These bonds are issued by companies that are rated below "investment grade" by third-party grading agencies. An issuer rated below investment grade is more likely to default on bond payments than a highly rated investment-grade issuer would be. Regional government bonds are among the safest, although these instruments tend to pay the most modest of income streams.
Money market funds are included in bond mutual funds. Money market funds invest in select short-term bonds, which are debt instruments that mature in a much shorter time period than traditional bond securities, which can be anywhere from three months to 30 years. A benefit of these short-term securities is that they tend to yield more favorable returns than average savings account interest rates would pay.