A bond is a negotiable debt security under which the issuer borrows a given amount of money, called the principal amount. In exchange, the borrower agrees to pay fixed amounts of interests, also called the coupons, during a specific period of time. Everything is well defined by the bond contract: the coupon rate is the interest rate that the issuer pays to the bondholder and the coupon dates are the dates on which the coupons are paid. Besides the issuer will repay the total amount of the principal when the bond will reach what is called maturity (or maturity date). In short, a bond is a securitized loan.

Why should buy?

Bond funds make bond investing easy for average investors. Investing in bonds profitably could soon be a different story. Now you know bond investing basics. Few average investors actually invest in individual bond issues like XYZ above. Instead, millions of Americans get into bond investing the easy way with bond funds. These funds pool investor money and manage a collection (portfolio) of these securities for their investors. When you invest money in a bond fund your money buys shares, and you then own a small part of a large portfolio of bonds. The fund actually owns the securities and buys and sells bonds on an ongoing basis. They pass the interest income on to investors in the form of dividends, and usually charge less than 1% a year for their services.

As a bond fund investor you can have your interest income send to you periodically or you can have these dividends reinvested automatically to buy more fund shares. The value or price of your shares will fluctuate along with the price fluctuations in the individual bonds held in the portfolio. You can buy or sell fund shares on any business day. You are not locked in. Now you know bond fund investing basics. So, here is the rest of the story. Remember, when you own bond funds you have an investment in bond securities. Whatever happens in the bond market and to the value of the bonds in your fund portfolio translates to gains and losses for you.

For whom it is suitable?

What is the maturity of the bond?

Another way to ask this question is How long will you need to hold the bond before you can get your money back? It is very important that you consider how soon you will need the money whether it will be used for a vacation, a new home or to fund your retirement. Another important factor to consider on this subject concerns liquidity. Is there a ready market for the bond if you need to sell it prior to the maturity date? Or will you need to find another means to fund that unforeseen opportunity?

Does it have early redemption features such as a call date?

Many investors have either been unaware of or have overlooked the call features on their bonds and other callable fixed income products. Many investors purchased bonds paying very attractive yields when rates were higher only to have them called away during the recent low interest rate environment. If you are counting on a high yield bond to provide the income that you need to buy your groceries you may be a bit surprised when your bonds are called away and you are looking at reinvesting in new yields that will barely cover a trip through the drive through window at your local fast food restaurant.

What is the credit quality?

What is the rating? Is it insured? Don not get too excited about that 7% yield until you find out whether the bond is investment grade or if it is junk! Credit quality is very important. If you can find a bond that is triple-A rated with insurance guarantying that you will receive all of your interest payments and all of your money back at maturity you might be happy. But, if you just blindly jumped on a bond that was paying 7% because it had a great yield you may be surprised to find out that the company might be on the verge of bankruptcy and you may never see your money again.

Investors should keep in mind that credit ratings may change after you purchase a bond or most other investments. Does Enron ring a bell? Many brokerage firms had buy ratings on Enron is common stock and Standard & Poor is even showed an A- rating on Enron is Common stock as late as October 2001. Unless you have been living under a rock you have probably heard what has happened to investments in Enron.Credit quality of the insurer is important too! While having an insured bond often lends us great comfort, the insurance on the bond is only as good as the quality of the company that is insuring it.

What is the interest rate?

How much am I receiving to lend my money to the issuer? Remember that you are actually loaning your money to someone else and you should be properly compensated. Is the interest rate appropriate for your time horizon? If you are receiving 3% on a two year bond you may be satisfied with the yield but you probably would not be satisfied with the same yield on a thirty year bond.

What is the price?

Many investors get so excited when they see a high yield bond that they forget to consider the price! A bond may originally have cost $1000 to purchase but with the changes in interest rates (as well as other factors) over time; the bond may be worth more or less than when originally issued. If a bond pays 7% interest but you pay $1120.00 to purchase it, the yield is not so attractive.