Money Essentials

Bond fund selection guidelines

Below are a few tricks of the trade when it comes to selecting the right bond fund for you.


1) Think low expenses

The single most important thing you can do to earn competitive returns in a bond fund is to opt for those with low expenses. As a general rule, bond index funds will have lower expense ratios than managed funds that invest in, say, munis and junk. With the latter, at least stick with below-average expenses.

2) Stick with short to intermediate maturities

Over the past 20 years or so, long-term bond funds have provided the highest returns, partly because interest rates have steadily declined over that period. That may not always be the case.

What's more, long-term bond funds can be surprisingly volatile. If interest rates rise just 1 percentage point, a long-term bond fund can drop 10% or more, wiping out more than a year's interest.

If you're investing for shorter periods - 10 years or less - or if you're using bond funds to add some ballast to a predominantly stock portfolio, then you may be better off with bond funds with short- to intermediate-term maturities - say, five to 10 years.

You can typically get 75 to 80% of the return of long-term funds, while incurring roughly 40% less volatility.

3) Beware tempting yields

Fund companies know that investors focus on yields. So some do everything they can short of putting the fund on steroids to pump up yields. They may throw some low-grade bonds into a government portfolio, or even invest in international bonds from countries where rates are especially high.

These ploys to boost interest may or may not pay off, but they all involve risks that are difficult to evaluate. A bond fund that's touting much higher yields than funds with similar maturities raises red flags - it's a sign that the fund is doing something much different, and probably much riskier, than its peers.

If a much higher-yielding offering can't explain its outsized yields by having ultra-low expenses, move on (or accept the fact that you're investing in a riskier-than-average fund).

calculator
Fund Screener
glossary
Glossary
take the test
Take
the test
more lessons
More Money Essentials
lessons
Features
They're hiring!These Fortune 100 employers have at least 350 openings each. What are they looking for in a new hire? More
If the Fortune 500 were a country...It would be the world's second-biggest economy. See how big companies' sales stack up against GDP over the past decade. More
Sponsored By:
More Galleries
9 reasons to be hopeful about women in tech These startups are working to leverage technology to level the playing field for minorities and women in tech. More
10 best states to retire in Forget Florida. Residents of these states are happy, safe, and have good health care -- all for the right price. More
5 celebrity-backed startups Jared Leto, Patrick Dempsey, Nas and Will.i.am have at least one thing in common. They're all startup investors. More