Debt funds are pooled investments, such as mutual funds and exchange-traded funds (ETFs), that hold debt securities, such as bonds and other fixed-income instruments. Debt funds are typically used for income investing or as part of a diversified portfolio and can be purchased through mutual fund companies or brokerage firms.
Debt funds, also called bond funds or fixed income funds, typically invest in dozens or hundreds of debt securities in one pooled investment. This means that an investor can buy just one debt fund and potentially get exposure to many different types of bonds, such as corporate bonds, US Treasury bonds, municipal bonds, and foreign bonds. Investors may also choose a debt fund that focuses on just one of those categories.
When an investor buys a debt fund, they do not actually own the underlying debt securities but rather shares of the fund itself. With debt funds, the investor does indirectly participate in the interest paid by the underlying debt securities held in the mutual fund or ETF. Also, mutual funds are not valued by a price but rather a net asset value (NAV) of the underlying holdings in the portfolio.
Bonds are debt obligations issued by corporations, governments or municipalities. When you buy an individual bond, you are essentially lending your money to the entity for a stated period of time. In exchange for your purchase, the borrowing entity will pay you interest until the end of a specified term. The end of the term, which is called the maturity date, is when you will receive the original investment or loan amount (the principal).
Here are the primary differences between bonds and debt funds:
People who invest in debt are typically investors wanting to diversify their portfolio. Debt funds typically perform differently than equity funds, AKA stock funds. For example, during a bear market, when stock prices are falling, bond prices are often rising. For this reason, combining stock funds with debt funds reduces the volatility (ups and downs) of your account value.
Some investors buy debts as sources of income in retirement. The mutual fund or ETF will pass along the interest earned on the bond holdings to the investors. Debt funds typically pay quarterly dividends, which include interest payments. Debt fund investors also participate in gains in prices of the underlying debt securities.
You can buy individual bonds through investment advisors, stockbrokers, or directly online with your own account through a no-load mutual fund company like Vanguard or Fidelity or a discount broker like Schwab or TD Ameritrade.
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