An Introduction to Investing in Corporate Bond Mutual Funds

If you were to consider investing your money in mutual funds, you would quickly discover there are many different types of these funds to choose from. Included in these different types are corporate bond mutual funds. As is the case with any other type of fund, they have their advantages and disadvantages. Some corporate bond funds offer a high rate of return, but those high rates are often accompanied by significant risks. Your best option may be to choose a fund that specializes in investment grade corporate bonds.

What Are Corporate Bonds?

When the town you live in needs to repave its streets or upgrade the sewer system and tax revenues are not sufficient to pay for those improvements the town may issue bonds to provide a source of revenue. When your school district sees a need for a new gymnasium, it is likely to issue bonds. When a corporation is in need of money, it will sometimes issue bonds. Bonds issued by businesses or corporations are called corporate bonds. These bonds promise a certain return to those purchasing them, and are therefore one way in which a person can invest his or her money.

Is Investing in Corporate Bonds Better than Investing in Treasury Bonds?

If better refers to the expected rate of return, the answer can sometimes be yes. It all depends on the corporation of course, as some will make investing in their bonds more attractive than will others. If risk is the issue the answer may be no. If you invest in corporate bonds issued by IBM, Boeing, or Anheuser-Busch, the chances are good that you will get a guaranteed return on your investment. If you invest in the corporate bonds issued by a startup company, there will likely be some risk involved. There is also the chance that a company may call its bond back in. You'll get your money back but perhaps not much more than that. One way to minimize these risks is to invest in several different corporate bonds, and one way to do that is to put your money in a mutual fund that either specializes in corporate bonds or includes them in its portfolio along with other bonds and stocks.

What Should One Be Looking for in a Corporate Bond Mutual Fund?

The obvious answer is a fund that has only high quality corporate bonds in its portfolio. Unfortunately for the average investor, finding that obvious answer is not always easy. Some mutual funds of this type will have a mix of corporate and Treasury bonds, or Treasuries. The corporate bonds normally have a higher interest rate, while the Treasuries provide stability and added security. Corporate bonds that pay a good rate of interest and are not considered risky are sometimes termed quality bonds, but are more often referred to as investment-grade corporate bonds.

Why Choose a Mutual Fund Instead of Investing in Corporate Bonds Separately?

About the only disadvantage of choosing a mutual fund is that there will be fees involved. The advantages of doing so however tend to outweigh the need to pay fees, which are often insignificant. Mutual funds offer greater diversification. They are professionally managed, and managed by those who know investment-grade bonds when they see them. These same professionals keep an eye out as to what the best sectors in the economy will be to make investments in at a given time. Many if not most corporate bond mutual funds also offer automatic dividend reinvestment if that is what an investor is looking for.

What About Taxes?

If you invest in corporate bonds yourself, the tax picture can easily become somewhat complicated, particularly if you are constantly buying and selling. The dividends you receive from bonds will be taxed as regular income. If you sell a bond at a profit, and have held the bond for less than a year, your profit will also be taxed as regular income. If you've held a bond for more than a year, you'll pay a capital gains tax on your profit. When you invest in a mutual fund, you are purchasing shares of the fund and not purchasing the bonds themselves. You only pay taxes on the profit you make when you sell shares, or any dividends that are paid out to you. As long as your money resides in a fund, you do not pay any taxes.

The bottom line might be that if you are planning to invest in corporate bonds the best approach would be to invest in one or more corporate bond mutual funds. To achieve even greater diversity, and further lower your risk, a good approach would be to invest in other types of mutual funds as well. Investing only in those funds whose portfolios consist strictly of corporate bonds could in some instances be a good decision, but investing in a mixture of corporate bonds, Treasuries, and stocks would probably be a better one.

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