What Are Intermediate-Term Bond Funds?
An intermediate-bond fund is a bond mutual fund that invests in a basket of intermediate-term bonds. An intermediate-term bond is one that matures not in the short-term or the long-term but in the medium term. Though definitions vary, they mature in about five to 10 years.
The maturity date is the point at which the bond issuer pays back the principal or face value of the bond. Investors earn interest on the bond during the period until maturity. Long-term bonds can last as long as 20 to 40 years, and for this reason, long-term bonds usually offer the highest interest rates.
Medium Interest Rate Risk
On the other hand, short-term bonds can last for less than a year or up to five years. They offer less interest rate risk than long-term bonds, but with their relatively low returns, they are often thought of as an alternative to money market funds. (When interest rates rise, the price of an existing bond goes down because investors would get a higher return by buying a new bond that pays higher interest.)
General investment wisdom dictates that short-term bonds are the place to be when rates are headed up, and you hope you have a lot in long-term bonds when rates are going down. When interest rates are uncertain, staying in the intermediate term is a kind of happy medium. There you take on less interest rate risk than you would with a long-term bond while getting a slightly better return than you might from a short-term bond.
Easier Than Buying Individual Bonds
With mutual funds, money from many investors is pooled and invested toward a specific goal or with a specific investment type in mind. Most individual investors would do well to invest in any type of bond through bond funds. They are easier to buy than individual bonds, and the prices are easier to understand. Plus you don't have to worry about competing with institutional investors over the best deals.
With a bond fund, you diversify your holdings, and you may be invested in a lot of different types of bonds: government, corporate investment-grade, corporate high-yield, municipals, and so on. That minimizes the risk of default wiping out all of your assets.
Intermediate-term bond funds are no different and will provide you with diversification within the intermediate-term bond fund class.
Look for Low Fees
As always, fees are the most important factor when choosing a mutual fund. The average domestic bond fund has an expense ratio of just above 1 percent. You may find a bond index fund that's even less costly. Most importantly, look for a no-load fund. Loads are additional commissions or expenses that you may pay at the front-end, when you first buy the bond, or on the back-end, once you sell.
It's also important to analyze risk in a bond fund. The various potential risks include the risk of default, country or foreign exchange risk, or too much leverage. (A leveraged fund borrows money to increase the amount it can invest.) Past performance doesn't matter as much because performance is mainly dictated by interest rate movement, which changes all the time. But you can compare the performance of the fund against a benchmark. A site like Morningstar can help you do so.
Maintaining a diversified mix of investments from different asset classes is an important element of any investment plan. That is why it is important to monitor your total asset allocation mix across all investment asset classes. Investment decisions should always be made with consideration to your time horizon and risk tolerance. Asset allocation models from the American Association of Individual Investors provide sample portfolios including intermediate-term bonds.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.