This month our focus is on bonds, specifically the question of whether it’s smarter to invest in individual bonds or in bond mutual funds. Many financial journalists, advisors, and investors question the wisdom of investing in bond mutual funds, especially when interest rates are expected to rise. They gain emotional security in knowing investors can buy and hold an individual bond to maturity and get their money back. What some fail to recognize is that bond mutual funds are merely diversified
portfolios of individual bonds, and both are equally exposed to the same market pricing mechanism. The day interest rates go up, individual bonds will fall in value just like bond mutual funds. Truth is, interest rate risk can be immunized with either individual bonds or bond mutual funds as long as the duration of the bond portfolio is appropriately matched to the desired investment horizon. The fact that an investor is able to get principal back at a specific maturity date adds no economic value compared to a bond mutual fund that does not have a specific maturity date. To unpack this story, we cite directly from research, noting sources along the way. This article is long, so we’ve tried to highlight key conclusions. Before we jump
in, a quick look at October market performance.