Investors looking for current cash flow as well as the potential for appreciation often use bond funds to get the results they need. Using a bond mutual fund is an excellent way to generate current income, but it is important to choose your bond funds carefully. Bonds are not without risk, and choosing the wrong bond fund for your needs could leave your principal at risk even as you continue to earn interest on your investment.
Contact several low cost mutual fund companies and request prospectuses for their bond mutual funds. Most large mutual fund companies will have many different bond funds to choose from, so it is a good idea to talk to a bond specialist at each firm. The specialist can evaluate your needs and help you chose the best fund for your needs.
Check the beta coefficient of each bond fund you are considering. The beta is a measure of how volatile each fund is. The lower this number the less volatile the fund should be. The stock market has a beta of one, so a bond fund with a beta of 0.50 is half as volatile as the stock market.
Review the classification for each bond fund and make sure it meets your needs and your tolerance for risk. Government bond funds are the safest, but they also have the lowest yields. Corporate bond funds and municipal bond funds tend to have higher rates, but they also carry a higher level of risk because they are not guaranteed by the government. High yield bonds, also known as junk bonds, carry the highest risk, since those bonds are issued by companies with low credit ratings and other financial problems. Mutual fund companies refer to their junk bond funds as high yield bond funds, and it is important for investors to be aware of this terminology. The yields on junk bond funds are high, but the risk of default is high as well.
Find the average maturity for each fund you are considering. Funds with a longer average maturity will be impacted more by changes in interest rates than those with shorter maturities. When interest rates are at historic lows, even a small uptick in rates could cause the value of your bond fund to go down.
Choose the bond funds that best meet your needs, and complete the application. Depending on the fund company you might be able to complete the application online. Otherwise, complete the application on paper and submit it, along with your initial deposit, to the address listed on the form.
Items you will need
- Mutual fund prospectus