Investing in Bonds – Individual or Funds?

By Gregory J. Cook, EA, CPA Author

 

When considering bonds as fixed income investments, you have several options available. Investors can purchase individual bonds, shares in a bond fund or shares in a bond unit investment trust. Which investment is right for you will depend on a variety of factors.

 

A Bond Fund

When you purchase shares in a bond fund, your money is pooled with that of other investors and the fund manager purchases and sells a variety of bonds based on the stated investment goals of the fund. Bond funds offer professional management, liquidity and a certain degree of diversification. Funds also generally carry higher costs than individual bonds. Bond funds may have an annual management fee and may carry a load as well.

 

Because bonds are constantly bought and sold out of funds, there is no set maturity date and monthly income payments fluctuate. Fund shares are redeemable with the fund company and may be purchased or redeemed at the current fund price at any time. Because bond funds are not required to hold bonds to maturity, the prices of the bonds in the fund may fluctuate. Investments in bond funds may lose value. The minimum initial investment varies among funds but is generally lower than the price of an individual bond. Bond funds are sold by prospectus, which you should read carefully before investing.

 

A Bond UIT

A bond UIT is a professionally selected, set portfolio of fixed income securities sold in unit amounts, typically with a minimum investment of $1000. It has a fixed maturity date for return of principal; therefore, the interest income one receives remains the same until the bonds in the portfolio mature, are called, or are sold. 

 

Unit trusts are sold at a “public offering price,” consisting of the value per unit of the bonds in the portfolio plus a sales charge.  Sales charges are typically 3.5% to 5% of the total public offering price based on the life of the trust, which can range from five years to 30 years.

 

Primary advantages of bond UITs include diversification (usually have from five to 25 different holdings), monthly income (some may also offer quarterly or semi-annual payment options), convenience (trustee handles all details of collecting & disbursing income, safekeeping of securities, & redemptions), and professional surveillance (underlying bonds are monitored daily by the sponsor & the trustee).  UITs are fully liquid—an investor can sell all or a portion of his holdings at any time, at the prevailing market price. Because the prices of bonds fluctuate, the current market price may be lower than what you purchased your shares for. Bond UITs are sold by prospectus, which you should read carefully before investing.

 

Individual Bonds

When purchasing a bond the bondholder becomes a creditor and has a senior claim on liquidation of assets over common and preferred stockholders in cases of bankruptcy. Therefore bonds are attractive because of their usually dependable income stream and preservation of capital feature. Bonds are considered fixed income securities because the bond has a fixed coupon rate (interest rate) and a fixed face value (principal amount). The bondholder usually receives the principal, their entire initial investment, if the bond is held until maturity. Bondholders receive interest payment throughout the life of the bond, most commonly on a semi-annual basis. There is a risk that the issuer will be unable to meet its financial obligations. Each bond issuer is rated as to its ability to make regular payments.  Bonds may be sold in the primary or secondary market at a price that may be greater or less then the principal amount. Bonds are usually sold in increments of $1,000 or $5,000.

 

Each bond investment offers different advantages and disadvantages. In order to determine which type of bond investment will work best in your situation, you will need to look at how this investment fits in with your overall financial plan. Does your portfolio need liquidity? A higher level of safety? Your individual portfolio needs will help your financial advisor choose the best investment option for you.

 

Choosing which securities will best help you meet your financial goals can be difficult. Consult with a qualified financial professional when making decisions about which investments will work for you.

 

 

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