BONDS VS. BOND FUNDS
WHICH IS RIGHT FOR YOU?
The combination of volatile stock prices and higher interest rates
has attracted many new investors to the tax-free bond market.
Although interested in earning tax-free income, investors are
uncertain whether they should buy shares of a bond mutual fund or
buy individual bonds.
Here is our two cents on the subject:
Tax-Free Bond Funds
There are two types of bond mutual funds: open-end and closed-end
(unit investment trust). Since open-end funds are predominant in
the industry, we will limit our discussion to this variety.
Open-end funds are by far the most popular. They function like
equity mutual funds. There is a portfolio manager who buys and sells
bonds. As money is invested in the fund, shares of the fund are
issued proportionally to the amount of money invested.
Theoretically, there is no limit to the amount of money that can
be accumulated in an open-end fund. As money is invested, bonds
are purchased by the fund manager and additional shares are issued.
At the close of each trading day, the share value is determined
by pricing the bonds held by the fund and dividing by the number
of outstanding shares. This is called the Net Asset Value (NAV).
On any day, a shareholder has the right to sell his shares back
to the fund at the NAV price, which is calculated at the close of
business on that day.
Bond funds, like stock funds, charge shareholders for the privilege
of investing in the fund.
Whether you buy a load or no-load fund, you will be charged a
management fee, ranging from 20 basis points to more than 1 percent
depending on the type of fund. With a load fund, you will also pay
a sales charge. Ask your broker to explain the various load plans
offered (A, B or C shares). These types of share plans allow you
to defer or eliminate some of the up-front sales charges, depending
on the length of time you are invested in the fund.
The Right Choice For You
Once you have made the decision to invest for tax-free income,
you must choose the vehicle that best suits your objectives.
Bond funds offer some unique benefits, but whenever possible,
we encourage investors to buy individual bonds. For the most part,
we believe municipal bond investors should employ a buy and hold
strategy.
We don’t believe bonds need to be actively managed, so we would
like to avoid the ongoing management fees. One percent doesn’t sound
like much, but when you are purchasing a fixed-income investment
that pays approximately 5.00%, the 1% management fee can reduce
your return by as much as 25% (1% divided by 5.00%). If interest
rates drop, the management fee can represent an even larger percentage
of your income.
To pay fees for professional selection of bonds is unnecessary.
If you ask the right questions and utilize Moody’s and S & P
ratings as general guidelines, you will have little problem constructing
your portfolio.
We recommend you purchase individual bonds, with some assistance
from a tax-free bond specialist, and actually create your own bond
fund. You can easily achieve diversification, marketability and
a system for reinvestment of interest payments.
Investors who are not in a position to buy round lots of bonds
should look to a bond fund to provide diversification and marketability.
Tax-free bond specialists are always available on the E-Desk of
FMSbonds.com. We can help you decide which approach to tax-free
investing is best for you.
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