Bonds are usually the first asset investors add to their portfolio to diversify their portfolio. But just adding a bond will not really diversify unless you choose the right bond fund. Here’s a look at some things to look for in a bond fund.

The Best Bond Fund
By James Leitz

The best bond fund for most average investors could be a high-yield, or long-term, or corporate bond fund. Then again, maybe not. This article takes you back to bond basics to find the best bond fund for most investors. Read on. You could save thousands, or make additional thousands based on the information presented here.

Getting back to bond basics, folks invest in bonds and bond funds primarily to earn higher income than they can get from stocks and savings vehicles like bank CDs. Few average investors invest in individual bond issues, because that requires significant knowledge and experience.

Bond funds, on the other hand, are professionally managed and offer investors diversification, sometimes at a reasonable cost. These funds hold bonds in their portfolio, and these bonds pay interest. This interest is passed on to investors in the form of dividends.

There is only one way I know of to get rich with bond funds. Wait until interest rates get historically high, as in the early 1980’s. Then, borrow a ton of money, and buy as soon as rates start to fall. Now, let’s get back to reality because interest rates are near historical lows.

When you buy shares of a bond fund these days, you are simply trying to get the highest income you can, without taking on heavy risk. As I have said in other articles, bond funds have interest rate risk. This means that if you invest now and interest rates go up in the future, the value of your investment will fall. Who wants a bond(s) that pays 6% when new bonds are paying 9%? Investors will buy it … but only at a reduced price.

NOW, let’s look for the best bond fund available. We will play “elimination” and weed out the risky ones and the losers. First, high-yield bond funds pay higher dividends for one reason. They hold high-risk bonds that are often referred to as JUNK. Second, long-term bond funds pay higher than average yields (dividends) because they have higher interest rate risk. Third, foreign bond funds are riskier because the value of the dollar fluctuates, and this could work against you.

Now, let’s eliminate bond funds because they pay lower dividends. Government bond funds invest in the likes of U.S. Treasury bonds, which are the safest on earth. And short-term bond funds are relatively safe because they hold bonds that mature in a few years. The problem is that neither of the above pays dividends worth taking any risk to get.

Now, we’re ready to zoom in on the best bond fund, which would probably be a higher-quality intermediate-term bond fund. We don’t need the highest quality, because we want good dividends.

I have in front of me such a fund, and it has a dividend yield of over 6%. But this is not the best bond fund I can find. The reason is that even though it is offered by one of the biggest and best mutual fund companies, it is rather expensive to buy and to own.

If you invest $10,000, 4% comes off the top for sales charges. Then, as long as you stay invested, 1% a year is taken to pay for expenses.

Now we save/make some money. The best bond fund is similar to the above, except that it costs you zero to buy it and yearly expenses are less than .25% a year vs.1%. This bond fund is a no-load, intermediate-term BOND INDEX FUND.

After all, we are not out to make a killing here, and a dollar saved is a dollar earned when it comes to bond funds.

A retired financial planner, James Leitz has an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals.

Jim is the author of a complete investor guide, Invest Informed, designed for average investors or would-be investors of all levels of financial background and experience. To learn more about investments and investing and his new financial guide go to http://www.investinformed.com

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