Any good investment in bonds always has trade-offs. Traditionally, one area of risk is the actual movement in the price of the bond. The higher the bond price goes, the less of a yield it provided. The lower a bond price goes, the higher the yield. The other form of risk is maturity length. The longer a bond has until maturity, the more risk it incurs. This is because any number of events can occur during the longer maturation period that could significantly affect the bond’s value.
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Rather than take on the low returns of a short-term bonds or the higher returns but higher risk associated with the maturation of long-term bonds, many investors prefer intermediate-term bonds. One of the concerns some investors have with long-term bonds is the degree of interest rate risk over time. Similarly, one of the drawbacks to short-term bonds is the low rate of return. Because of the low rate of return, investors often see short-term bonds as an alternative to money-market funds. The option of an intermediate-term bond allows for less interest rate risk than with a long-term bond, and offer a better rate than a short-term bond, while reaching maturity in between three and fifteen years. When interest rates are uncertain, an intermediate-term bond can be a balanced solution for investors.
Intermediate-term bonds can also be grouped together into a type of mutual funds called intermediate-term bond funds. These funds are a way to diversify holdings and simplify the buying process. In the same way that many investors combine their money in order to invest in a particular type of investment in a traditional mutual fund, in an intermediate-term bond fund, numerous investors pool their money and invest in specific types of goals, allowing for a more diverse portfolio of bond holdings. These investments can range from mortgage- and asset-backed securities to government and corporate holdings. Through this diversification, investors are protected from defaults proving catastrophic to their holdings while streamlining the buying and price tracking process. Intermediate-term bond fund prices are easier to understand than individual bond prices, they are also far simpler to purchase and remove any negotiation from the buying process.
When purchasing an intermediate-term bond fund, investors should consider several factors. The first of these, and the most important, is fees. The average domestic bond fund should have an expense ratio of just over 1% or less. Investors should seek out no-load funds—funds that have no commissions or additional fees at any point of purchase or sale. Secondly, investors must analyze the risk in a bond fund. Potential risk can come from things like foreign exchange or country risk, risk of default. Because bond fund performance is based on current and future interest rate movement, it is not essential to consider a bond’s past performance. For investors who are concerned, however, the fund’s performance can be compared to a benchmark through an investment resource like Morningstar.
Intermediate-term bond funds are an excellent option for investors seeking a balanced, diverse, mid-length investment solution without the risk of long-term bonds or the low rates of short-term bonds.
About Lawrence Meyers
Larry is regarded as one of the nation’s experts on alternative consumer finance. He consults for hedge funds and private equity via his Council Member status at Gerson Lehman Group, and as a member of Coleman Research Group’s Executive Forum. He also consults for Credit Access Businesses and Credit Services Organizations in Texas. His Op-Eds and Letters to the Editor have appeared in over two dozen major newspapers. He also brokers financing, strategic investments, and distressed asset purchases between private equity firms and businesses of all stripes. You can reach him at firstname.lastname@example.org.
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