Bonds vs. Bond Funds This Smart Money article discusses the different risks invloved in investing in bonds vs. bond funds. Typically investors expect bond funds to be less risky because they are diversified but this is not always the case because there is no fixed yield or obligation of returning the principle. With bond funds the risk-return ration is contantly changing. Depending on what investors are expecting in return there are several questions they should ask themselves before choosing to invest in bonds or bond funds.

Bond funds can be even trickier than bonds themselves because -- unlike the implication in their name -- they are not really fixed-income investments. Even when a mutual fund's portfolio is composed entirely of bonds, the fund itself has neither a fixed yield nor a contractual obligation to give investors back their principal at some later maturity date -- the two key fixed characteristics of individual bonds.

In addition, because fund managers constantly trade their positions, the risk-return profile of a bond-fund investment is continually changing: Unlike an actual bond, whose risk level declines the longer it is held by an investor, a fund can increase or decrease its risk exposure at the whim of the manager. In this way a bond fund is closer in character to equities than it is to individual bonds.

Bond funds may be appropriate for investors who know exactly why they are going into these funds and what they expect to get out of them.