Bonds and mutual funds are popular investment options that offer differing levels of risk and can help balance your portfolio.
Understanding the difference between mutual funds and bonds will help you work out whether to invest in one or both of them.
What are bonds?
A bond can be compared to a loan. If a government or company needs to raise money, they may issue a bond. This means they’ll borrow the money from investors, usually at a fixed interest rate.
The issuer will promise to repay the principal value of the bond (the amount they borrowed) on a specific 'maturity' date. The length of time they borrow the money - for example 2 or 5 years - is known as the term.They’ll also promise to make regular interest payments, expressed as a percentage and known as the coupon rate.
If you invest in a bond and keep it until it matures, you should get back the money you put in, as well as the interest payments you receive along the way. So it’s generally seen as a stable return on your investment.
Some bonds are considered low-risk, but there are also complex and high-yield bonds that can have a higher risk than many mutual funds. Remember, all investments carry risk.
These are the main types of bonds:
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Corporate bonds – issued by companies
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Government bonds - issued by governments
Bonds can be traded on the open market before they mature, which means their market value can fluctuate according to demand. Their value can be affected by factors like rising interest rates or changes in the credit rating of the issuer.
| Pros | Cons |
|---|---|
| Diversify your portfolio and reduce risk | Returns may be lower than with other investments, high entry points |
| Fixed income stream from interest payments | Bond prices drop if interest rates rise |
| A potential way to preserve your capital | If the issuer defaults you could lose your money |
| Variety of maturities, from short to long-term | Inflation risk, especially with longer-maturity bonds |
| Pros | Diversify your portfolio and reduce risk | Diversify your portfolio and reduce risk |
|---|---|---|
| Cons | Returns may be lower than with other investments, high entry points | Returns may be lower than with other investments, high entry points |
| Pros | Fixed income stream from interest payments | Fixed income stream from interest payments |
| Cons | Bond prices drop if interest rates rise | Bond prices drop if interest rates rise |
| Pros | A potential way to preserve your capital | A potential way to preserve your capital |
| Cons | If the issuer defaults you could lose your money | If the issuer defaults you could lose your money |
| Pros | Variety of maturities, from short to long-term | Variety of maturities, from short to long-term |
| Cons | Inflation risk, especially with longer-maturity bonds | Inflation risk, especially with longer-maturity bonds |
Find out more about bonds.
What are mutual funds?
If you want to invest in a range of assets, then a mutual fund could be an option for you.
Mutual funds pool money from different investors and then buy a range of assets, such as equities and bonds. So when you invest in a mutual fund, you’re buying a share of what it’s invested in.
You can earn returns on a mutual fund through capital gains, as the fund’s assets increase in value, or through income from dividends and interest. This income can either be taken or reinvested in the fund.
The main types of mutual funds are:
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Stock funds
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Bond funds
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Money market funds
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Multi-asset funds
For many investors, the main benefit is that mutual funds are managed by professional fund managers. This means you don’t have to spend too much time researching what assets to buy, managing them, and keeping up to date with market fluctuations.
Here are some of the pros and cons of mutual funds:
| Pros | Cons |
|---|---|
| Risk is spread across different assets in a fund | No guarantee of positive returns |
| Professionally managed by experts | Management fee, regardless of performance |
| May allow you to reinvest your dividends | Spreading risk too widely can limit returns |
| Easy to buy and sell, initial investment generally lower than with bonds | Limited control |
| Pros | Risk is spread across different assets in a fund | Risk is spread across different assets in a fund |
|---|---|---|
| Cons | No guarantee of positive returns | No guarantee of positive returns |
| Pros | Professionally managed by experts | Professionally managed by experts |
| Cons | Management fee, regardless of performance | Management fee, regardless of performance |
| Pros | May allow you to reinvest your dividends | May allow you to reinvest your dividends |
| Cons | Spreading risk too widely can limit returns | Spreading risk too widely can limit returns |
| Pros | Easy to buy and sell, initial investment generally lower than with bonds | Easy to buy and sell, initial investment generally lower than with bonds |
| Cons | Limited control | Limited control |
Find out more about mutual funds.
What's the best option for you?
Bonds and mutual funds can both play an important role in a well-diversified investment portfolio.
Bonds provide a regular income and some are considered a low-risk investment, but may offer lower returns. Mutual funds, on the other hand, may offer higher potential returns but also come with higher risk.
As with all investment decisions, you should weigh up your financial goals, risk tolerance and timeframe before making a decision.
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