A bond fund is a mutual fund that includes as part of its investment objective the requirement to invest its resources primarily in the debt instruments of corporations, municipalities or governmental entities. Bond mutual funds provide investors with the same types of benefits as equity mutual funds, including diversification and professional management of assets, but different types of bond funds may provide different types of risks and rewards. The average return on a bond fund can be affected by the types of bonds the fund holds.
Bond funds are not without risk. Like all interest-bearing securities, the price of bonds held in a bond mutual fund can fluctuate in the secondary market based in part on prevailing interest rates and the economic soundness of the issuing entity. The prices of bonds tend to move in the opposite direction of prevailing rates, so if interest rates rise, the value of bonds in the fund will decline, resulting in a decrease in the fund's net asset value. If the creditworthiness of the issuer is upgraded or downgraded, the value of the bond will respond accordingly.
Government Bond Funds
Mutual funds that invest primarily in debt obligations of agencies of the U.S. government may be considered safer than other types of bond funds, since U.S. government bonds are backed by the full faith and credit of the government. Keep in mind, however, that it is only the bonds that have this backing. The bond mutual fund has no such backing. The average return on government bond funds will vary based on the period of time being measured and on the longevity of bonds held in the fund. The five-year average for short-term government bond funds was 4.2 percent as of Feb. 16, 2012, according to the Morningstar Government Bond Index Performance. The three-year average for long-term government bond funds was 8.57 percent, while the one-year average for intermediate government bond funds was 10.78 percent.
Municipal Bond Funds
Investors who are in higher tax brackets may prefer to invest in bond funds that specialize in municipal bonds, since the interest on these bonds is typically free from federal income taxes. The average return on municipal bond funds may be tracked based on a wide range of investment objectives, and may vary significantly based on the time-frame used to derive the average. The five-year average return for high-yield municipal bond funds was 2.17 percent, while the one-year average return was 15.96 percent as of Feb. 17, 2012, according to the Morningstar website. Morningstar reported that the five-year average return on intermediate-term municipal bond funds was 4.42. The three-year average for short-term municipal bond funds was 3.2 percent.
Fixed Income Bond Funds
Fixed-income bond funds may invest in a variety of debt instruments, including bonds issued by corporations. The average return on fixed-income bond funds may vary significantly based on the fund's investment objective. High-yield bond funds may invest in riskier, non-commercial grade bonds commonly referred to as junk bonds in order to generate a higher yield. The three-year average return on high-yield bond funds was 19.51 percent as of Feb. 17, 2012, according to the Morningstar website. The three-year average return on multi-sector bond funds was 15.18 percent, and the three-year average return on short-term bond funds was 5.04 percent.