According to financial analyst firm Aon Hewitt, intermediate-term bond funds are among the most common investment choices in a 401(k). So what is an intermediate-term bond fund?What Is an Intermediate-Term Bond?
An intermediate-term bond is one that matures not in the short-term or in the long-term. It matures in the medium term. Just what the intermediate term is, that's not as easy to define. Some say three to 10 years. Some say the intermediate term can last for 15 years.
The length of time to maturity really does matter. Those who know bonds understand that the maturity date is the point at which the bond pays back the principal or face value of the bond. Investors earn interest on the bond until maturity, also known as the duration of the bond. 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. On the other hand, Short-term bonds can last for less than a year 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.
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. Stay in the intermediate term, and you take on less interest rate risk than you would with a long-term bond while getting a slightly better rate than you might from a short-term bond.What Is an Intermediate-Term Bond Fund?
An intermediate-bond fund is a bond mutual fund that invests in a basket of intermediate-term 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 bonds through bond funds. They are easier to buy, the prices are easier to understand. You don't worry about fighting 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, high-yield, muni bonds, asset-backed securities, mortgage-backed securities and so on. This helps minimize the risk of default wiping out all of your assets.
Intermediate-term bond funds are no different. An intermediate-term bond fund will provide you with diversification within the intermediate-term bond fund class. And may offer you a way to play both sides of the bond market.What to Look for in an Intermediate-Term Bond Fund?
So what should consumers look for in an intermediate-term bond fund? As always, fees are the most important factor. The average domestic bond fund has an expense ratio of just above 1%. 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. 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 that.
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