How a bond fund works
Your bond fund is made up of a series of individual bonds carefully selected by the fund manager. This is how those individual bonds work:
- A government or a company issues bonds. A company may issue a bond to help finance new business opportunities, or a government may use it as a way of helping finance their infrastructure.
- Typically, the bond will have a fixed life. The end of this fixed life is known as the 'redemption date' but is also referred to as 'maturity'.
- The bond is issued at a fixed price. This is called the face value or the par value. The issuer of the bond will repay the face value to the bondholder at the redemption date. The face value may be different to the price that was actually paid for the bond as the bond may have been bought and sold in the open market.
Bonds can be bought and sold in the open market throughout their lifetime. Once bought, you do not have to hold onto it until the redemption date.
Although the price of the bond is set at the beginning of its lifetime and at maturity, it will fluctuate between these times. The price of a government bond is affected by factors such as inflation and government base rates. Economic factors such as interest rates, and the fortunes of the issuing company affect corporate bonds.
Typically, the issuer of the bond will make a regular interest payment to the bond holder. This is called the 'coupon'. The level of the coupon will be agreed when the bond is first issued and will not change.
While bonds are a viable investment option, the average minimum amount needed to invest is about RM 5 million – which puts them out of the reach of most ordinary investors. Bond funds, on the other hand, are much more investor-friendly.
Bond funds are seen as an income generating investment, and therefore they will appeal to anyone with an income need, such as someone nearing retirement.
Even better, any interest income or profit earned from the Fund (at least, from certain fixed income securities) is exempt from tax. How’s that for an additional way to make your money work harder?
In times of low inflation, investing in bonds is a good way of maintaining a stream of income that will have a high 'real' value.
In addition, in times of low interest rates, the income received from a bond fund investment will be higher than that offered by the banks. Although of course a bank is always the safest place for your money compared to a bond fund where the value of your investment can fluctuate and you may not get back your original investment.
Additionally, someone who already has investments in the stock market might choose to invest in a bond fund in order to diversify the level of risk to which their savings are exposed.
Want to know what kind of bond funds that are available? Check out our bond funds here