How Does Time Value Of Money Relate To Valuation Of Bonds

How to Make Money Investing in Bond Funds

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When it comes to investing, most investors focus on stocks but know little about bonds and bond funds. These alternatives to bond funds are attractive because they sometimes offer very high returns.

Some popular alternatives to bond funds are:

Stocks
Commodities
Synthetic Derivatives
ETFs
REITs (Real Estate Investment Trusts)

Below, we show you how you can use bond funds to meet, or exceed, your investment goals.

The Best Bond Funds for Investment Income

Bond funds are a tool that, in the hand of the sophisticated investor, can yield enormous profits. The typical investor, however, often does not know how to invest in bond funds properly and therefore loses his money outright. To invest profitably in bond funds, you must know how the money is made in this industry, and where the market is headed. This requires careful study and paying attention to the movement of fundamentals in the market, more so than just looking at prices. In addition, the careful investor looks at funds that have the best performance.

When it comes to investing for income or free cash flow, some bond funds stand out for more consistent income returns. These funds work well for people who need a reliable income stream from investments, such as retirees. A selection of such funds includes:

Vanguard Limited-Term Tax-Exempt - This investment fund is tax exempt, and so will return more money to you that would have gone into paying taxes. It invests in BBB grade or better municipal bonds. As such, it is quite safe and conservative.
DoubleLine Total Return N - This fund offers higher yield due to a mix of safe and riskier investments. This can result in you receiving a bit more investment income as you need the cash flow.

Highest Yielding Bond Funds

The highest yielding bond funds are those that are perceived as the riskiest. Bond investing comes with some unique features based on the relationship between bond prices and interest rates. The interest rate determines the amount of money that the bond issuer will pay you, the investor, every year. Many bond issuers pay out the interest payment twice a year, that is, once every six months. The interest payment is also called the yield.

A $20,000 bond investment with a yield of 10% would, therefore, pay $2,000 a year. Such a high yield is unusual when the economy is doing well or when interest rates are low. In times of economic crisis, however, much higher yields will prevail. Riskier bonds and funds that invest in them will tend to pay a higher yield. This is because they must compensate the investor for the additional risk of investing in the risky company or issuer.

Selecting Corporate Bond Funds

Corporate bond fund yields vary greatly depending on interest rates in the broader market as well as the risk profile of the underlying bond investments. A very safe fund that focuses on the most financially sound corporate bonds will yield less than a fund that takes more risk. It is important to realize that a higher yield corporate bond is also, on average, a riskier investment. If the company does not default on the bond, you make more money than with a safer investment. However if the company defaults, which happens more frequently than you might think, you not only lose interest payments, but your principal invested as well.

Vanguard Long Term Investment Grade Fund is one corporate bond fund with a good corporate bond yield. Its 3.75% yield is higher than some other corporate bond funds but still lower than a variety of riskier options.

PIMCO Investment Grade Corporate Bond Fund returns around 3.37%. It seeks to maximize total returns while preserving capital.

The Best Bond Funds for Long Term Investing

When it comes to the best total return bond funds, you have to consider the track record of the fund. Generally, big institutional investors like BlackRock and PIMCO tend to have the best bond investment track records. Newer bond funds with less track record might offer incentives such as lower fees, but their skill has not been tested over the long haul. As a result, it's a good idea to consider funds such as PIMCO Long-Term Credit Fund and Vanguard Long-Term Bond Index Fund. These are funds with a strong oversight and investing due diligence. They might not offer the highest returns all the time, but will manage your money better in the long run.