Since many of today’s financial advisors got into the business in the 1980s and 90s, during the best stock market in U.S. history, most have become stock market specialists. Frankly, if they do fixed income, it’s usually an afterthought, and most will simply take the easy way out and invest their clients’ money in bond mutual funds.
What many people don’t realize is that bond mutual funds carry risks, costs, and tax implications that can be reduced, or even eliminated, by investing in a diversified portfolio of individual bonds, or other fixed-income securities.
That’s because when an investor buys an individual bond, they receive two important guarantees. First, they’re guaranteed a fixed rate of interest for the life of the bond. Second, when the bond matures, they’re guaranteed their principal back—assuming there have been no defaults. With that assumption, an investor knows what they’re going to earn on the bond if they hold it to maturity. They also know the maturity date and the name of the company they are invested in. But what about bond mutual funds? How do they compare to individual bonds?
For starters, both guarantees that come with individual bonds are “off the table,” so to speak, when it comes to bond mutual funds. Bond mutual funds don’t pay a fixed rate of interest. The interest they pay fluctuates. What’s more, bond mutual funds never mature; your investment in the fund will continue until you decide to liquidate it.