About Corporate Bond Funds

Significance

• Corporate bond funds frequently choose their bonds based on market sector and bond ratings. In general, bond funds do not mix bonds of different ratings. Each public bond is rated on a scale from AAA---investment grade, comparable to US treasuries in terms of security---and CCC, or junk, high-yield bonds that are often already in default. Bond funds are also often divided into long-term and short-term funds. Long-term funds often have higher yields but greater risk, as there's more time for the bonds to potentially be downgraded.
  
  

Function

• Compare bond funds based primarily on their posited returns and fees charged for investing in them. Keep in mind that corporate bond funds are taxed at higher rates relative to government bond funds and are also subject to declines in value should the underlying bonds enter default or partial default. Investigate the individual bonds within the fund before you invest in it. Merely because a bond has a high rating does not mean that it will maintain its value throughout the lifetime of the bond. Learn more about the company in question.
  
  

Features

• Watch out for funds that are labeled "high-yield." High-yield bonds are generally those that are rated BBB or lower and are more commonly referred to as highly risky junk bonds. The returns on junk bonds are very high, and the risk of default is compounded even further when they are aggregated into a fund. Junk bond funds can have startlingly high returns in strong economic environments, but they tend to be very dangerous investments in bear markets.
  
  

Considerations

• Limit your risk by investing in a short-term bond fund rather than a long-term one. If you are going to invest in a long-term fund, make sure that you can afford losing part or all of your principal. Much can change over a period of several years, and generally speaking, it only makes sense to invest in long term corporate bond funds if the companies involved are extraordinarily stable and well capitalized. If you're interested in more long-term hedged investments, it can help to invest in a mutual fund that is only partly composed of corporate bonds.
  
  

Benefits

• Investing in corporate bond funds rather than directly in corporate bonds gives you far greater liquidity. It enables you to exit the position without taking major losses. You can even put a stop-loss order on your investment in a corporate bond fund that will serve to protect your investment in the case of significant drops. This allows you to benefit from the stability and good returns of bond investment without taking on as significant risks so long as you monitor your position.