Choosing a bond fund
A realistic assessment of history suggests that you start with a bond index fund. A rational investor will hold no-load index funds to pay minimal fees and low taxes.
On the other hand, it is possible that an actively managed bond fund will have a greater return. Forbes tells investors on its site that the best bond funds “… are not only stingy with overhead costs, but also have done a decent job in delivering risk-adjusted returns over the long haul.”
Fidelity and Vanguard funds are persistent top performers in most bond fund families. Other top-performing bond funds include American Century, T. Rowe Price and USAA. For long-term return, the PIMCO Total Return bond fund (PTTDX), is run by Bill Gross. He was recently warning about the deflation risk, but as to his fund’s history, its return exceeded the Lehman Aggregate Bond Index in most of the years ending 2005.
If you are in a high tax bracket and want to generate tax-free interest income, you may want to include municipal bond funds in your portfolio. If you’re subject to the Alternative Minimum Tax, consider whether a fund buys municipal bonds subject to the AMT. If a fund holds taxable bonds, your income will be currently taxable, unless the funds are held in a tax-sheltered retirement account. Income dividends from non-AMT municipal bond funds will be exempt from federal tax but may be subject to state and local income taxes, depending on the laws of your state.
In choosing a fund, consider your level of credit risk tolerance, and the interest-rate risk.
For an example, assume that you want safe taxable income higher than the return from a broad-market bond index. You may want on a long-term, investment-grade corporate bond fund. This assumes that you are willing to bear the interest rate risk, that interest rates will go up and the value of your fund goes down.
You can get information from Yahoo.com, or from Morningstar reports at your library. If you start with Yahoo.com, on the left of the home page click on “Finance.” At the top of the Finance page, hover on the Investing tab, and click below the tab on “Mutual Funds.” On the left, under “Tools”, click on “Fund Screener”.
The fund screener may have some bugs, since a test would not show much even though the criteria were set to be as broad as possible. In the alternative, you may want to look on websites such as vanguard.com, fidelity.com or pimco.com.
Other information sources include morningstar.com. For a Morningstar star rating, a fund must be in existence for three years. In the free online version of Morningstar, the list of funds does not include all the funds tracked, and exchange-traded closed-end funds and open-end mutual funds are mixed together. Important criteria include fund fees, the kinds of bonds included in the portfolio, the duration of the bonds held, credit quality of the bonds held, and the annual returns.
For additional information, see also forbes.com, and (under a paid subscription model) the Wall Street Journal site, www.wsj.com.
