Investing in Bonds in a Bond Fund.

 Purchasing bonds by owning a bond fund is simple in comparison to selecting individual bonds. Few average investors can analyze bonds, so the great majority investing in bonds buy a mutual fund called a bond fund, and let professional money managers make the selections for them. Hence, whenever you own a bond fund you have element of a professionally managed portfolio of bonds, often called an income fund. premium bonds to invest

Don't get confused. Purchasing bonds or an income fund has little in keeping with buying U.S. Savings Bonds. The government guarantees that you will not lose money in savings bonds. There is no market risk in these savings products. When investors talk about bonds they're not talking about savings bonds.

A connection fund might be labeled as an income fund, because the primary objective is to supply higher income vs. other investments. These funds pay dividends from the interest earned on the bonds in the fund portfolio. Along with this particular higher income, investing in bonds involves risk. Bond prices or values fluctuate because bonds are marketable securities that trade in the open market, much like stocks do.

In order to understand investing in bond funds, you first need to learn some bond basics. Let us turn our attention now to a simplified bond example, a brand new issue of a very basic corporate bond.

ABC Corporation decides to boost a sizable amount of money to expand their operations. As opposed to selling stock to the public, they decide to market bonds. Put simply, they will borrow money from investors. Each bond has a face value or initial bond price of $1000. The coupon rate will be 6%. These are good quality bonds and mature in 2039. Once all of the bonds can be bought ABC gets their money, and these bonds start to trade in the bond market.

If you buy an ABC bond for $1000, ABC promises to pay for you $60 each year, or 6%, for as long as you have it until 2039 once the bond matures. In those days the bond owner gets the $1000 back, and the bond no longer exits. Until that point the deal never changes. ABC promises to pay for the bond owner $60 each year, period.

You as a bond holder are not required to put on the bond until 2039. You can sell it at will on the bond market, or buy more bonds at selling price if you wish. But beware that bond prices fluctuate, as do stock prices. Bond prices or values can go up and they can go down. In other word, a $1000 bond is definitely not worth $1000 after it's issued. Hence,there is market risk involved when investing in bonds.

Now picture an income fund invested in a portfolio of bonds similar to ABC bonds. Because this bond fund holds a wide selection of different bonds, investors do not need to be concerned about an organization like ABC going broke and not making interest payments or not paying investors back upon maturity. The fund is broadly diversified.

The true risk you should be aware of when investing in bonds and bond funds is of an alternative nature, and this risk is known as interest rate risk. Interest rates in the economy fluctuate, but a bond's coupon rate does not. ABC bonds, for instance, pay $60 each year, period.

What goes on when long term interest rates in the economy go up? Simply this: the worth of existing bonds, in other words bond prices, go down.

Look at it this way. If interest rates double and go from 6% to 12%, new bonds will be paying investors $120 each year in interest vs. $60. What do you think investors in the bond market would be willing to fund a 6% bond under these circumstances? Since investors buy bonds for the larger interest they give, the buying price of our 6% bond will fall like a rock. The bond price will not likely fall by 50 percent, nonetheless it will be heading for the reason that direction.

Interest rates peaked in 1981-82, and have generally been falling since. Unlike our above example, falling interest rates send bond prices higher. Investors in bonds and bond funds get income from interest or dividends when interest rates fall, plus the worth of their investment increases.

But interest rates can not fall forever. Once they do head north again many folks invested in bond funds or income funds will be caught standing flat footed. Invest informed and understand this: When interest rates go up significantly, the worth of your bond investments will fall.

A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to achieve their financial goals.