We get asked this question a lot, especially by people concerned about rising interest rates. It might be challenging to select the solution that best suits your needs if you are unfamiliar with all the details of each choice.

Each strategy has advantages and disadvantages, and the optimal choice for you will depend on your specific investment objectives, including your time horizon and risk tolerance.

Interpersonal Ties

Bonds normally have set principal values (or face or par values) that are repaid at maturity and typically pay semi-annual coupon or interest payments. The price of a particular bond may change on the secondary market even though the par values are typically set based on the movement of interest rates. Bond prices normally decline as interest rates rise and vice versa. The bond price will typically converge with its par value as it gets closer to its maturity date. An opportunity cost is associated with keeping a bond until it matures: You risk missing out on the higher coupons given by newer bonds on the market if rates rise while you keep the bond. Barring bond default, the main advantages of owning individual bonds are:

A steady source of income that is excellent for planning: A consistent revenue stream might help an investor plan for anticipated recurring needs, such as college tuition.

A maturity value that can be predicted: You will get the bond's par value at maturity, barring default, assuming the bond is not callable (available to be called back by the issuer at or above par before its maturity date). If you want to hold the bond until it matures, knowing this may help you disregard any price changes.

The bond's purchase price determines the personal cost base, Your cost basis for individual bonds, and the amortisation of any premium or discount received. For tax planning, this function is beneficial.

The drawbacks of holding individual bonds include:

To accomplish diversification, you require a sizable number of bonds. The fixed income market has many different sub-asset classes. Therefore diversification may be challenging to achieve with merely individual bonds. Diversification across issuers is equally as important as diversification within sub-asset groups. Some investors may find it prohibitively expensive to invest the amount necessary to attain this level of diversification1.

Pricing is typically less appealing than that offered to institutional investors. Individual investors typically pay more for bonds than institutional investors, who buy big volumes of bonds all at once. When buying individual bonds, you must consider the price you're paying.

Mutual bond funds

Bonds with a range of maturities, coupon rates, and credit ratings are typically held by bond mutual funds in considerable quantities. Unlike individual bonds, which typically pay interest twice a year, distributions from bond funds are typically made monthly. They can either be paid to the investor directly or reinvested to increase profits. One significant distinction between individual bonds and bond funds is that, particularly in a rising-rate environment, there is no assurance that you will recoup your principal with the bond funds at a specified time.

The main advantages of bond fund ownership are:

Greater diversification for every dollar invested: Using a fund gives you exposure to various bonds, making it considerably simpler to build a diverse bond portfolio for every dollar invested.

Bond funds typically receive better pricing on individual bonds than do individual investors. Access to institutional pricing. A lower price corresponds to a higher yield, all things being equal.

Professional leadership: There are many complexities in some of the riskier subsectors of the fixed income market, such as high-yield bonds, bank loans, or preferred securities. To properly navigate them, you need to have a solid understanding of credit analysis and industry trends. If the fund is managed more actively, the manager is also given the option to buy or sell bonds in response to changes in interest rates, potentially boosting returns and income.

The drawback of investing in bond funds is:

The cost of management The more actively traded bond funds may have greater management fees, resulting in poorer returns. In contrast, owning individual bonds often involves a commission fee at the time of purchase and no additional fees until the bond is sold before its maturity.

The market's fluctuations will affect the net asset value (NAV): There is no way to predict what the NAV of a certain bond fund will be at some time in the future because it fluctuates with changes in interest rates. Bond funds are less desirable when preparing for potential obligations than individual bonds.