Purchasing Bonds inside a Bond Account.

 Purchasing bonds by owning a relationship fund is easy in comparison to selecting individual bonds. Few average investors can analyze bonds, so the great majority investing in bonds obtain a mutual fund called a relationship fund, and let professional money managers make the selections for them. Hence, whenever you own a relationship fund you possess section of a professionally managed portfolio of bonds, often called an income fund.

Don't get confused. Purchasing bonds or an income fund has little in accordance with buying U.S. Savings Bonds. The government guarantees that you will not lose profit savings bonds. There is no market risk in these savings products. When investors talk about bonds they're not referring to savings bonds.

A relationship fund is sometimes called an income fund, because the principal objective is to supply higher income vs. other investments. These funds pay dividends from the interest earned on the bonds in the fund portfolio. Along with this particular higher income, investing in bonds involves risk. Bond prices or values fluctuate because bonds are marketable securities that trade in the open market, similar to stocks do.

In order to understand investing in bond funds, you first should try to learn some bond basics. Let's turn our attention now to a simplified bond example, a new dilemma of an extremely basic corporate bond.

ABC Corporation decides to boost a sizable amount of money to expand their operations. Rather than selling stock to the public, they decide to offer bonds. Quite simply, they will borrow money from investors. Each bond has a face value or initial bond price of $1000. The coupon rate is likely to be 6%. These are high quality bonds and mature in 2039. Once all of the bonds are sold ABC gets their money, and these bonds begin to trade in the bond market.

If you purchase an ABC bond for $1000, ABC promises to pay for you $60 per year, or 6%, for as long as you possess it until 2039 when the bond matures. At that time the bond owner gets the $1000 back, and the bond no longer exits. Until that time the offer never changes. ABC promises to pay for the bond owner $60 per year, period. premium bonds to invest in the UK

You as a relationship holder are not required to put on the bond until 2039. You are able to sell it at will on the bond market, or buy more bonds at market price if you wish. But beware that bond prices fluctuate, as do stock prices. Bond prices or values can increase and they can go down. In other word, a $1000 bond is definitely not worth $1000 after it is issued. Hence,there's market risk involved when investing in bonds.

Now picture an income fund invested in a portfolio of bonds much like ABC bonds. Because this bond fund holds a wide selection of different bonds, investors will not need to be concerned about a company like ABC going broke and not making interest payments or not paying investors back upon maturity. The fund is broadly diversified.

The actual risk you ought to be aware of when investing in bonds and bond funds is of a different nature, and this risk is called interest rate risk. Interest rates in the economy fluctuate, but a bond's coupon rate does not. ABC bonds, as an example, pay $60 per year, period.

What happens when long term interest rates in the economy increase? Simply this: the worth of existing bonds, quite simply bond prices, go down.

Look at it this way. If interest rates double and go from 6% to 12%, new bonds is likely to be paying investors $120 per year in interest vs. $60. What do you think investors in the bond market would be willing to pay for a 6% bond under these circumstances? Since investors buy bonds for the larger interest they give, the price tag on our 6% bond will fall like a rock. The bond price will not likely fall in two, however it is likely to be heading in that direction.

Interest rates peaked in 1981-82, and have generally been falling since. Unlike our above example, falling interest rates send bond prices higher. Investors in bonds and bond funds get income from interest or dividends when interest rates fall, plus the worth of the investment increases.

But interest rates can't fall forever. Once they do head north again many folks invested in bond funds or income funds is likely to be caught standing flat footed. Invest informed and understand why: When interest rates increase significantly, the worth of one's bond investments will fall.

A retired financial planner, James Leitz comes with an MBA (finance) and 35 years of investing experience. For 20 years he advised individual investors, working directly with them helping them to reach their financial goals.