Municipal Bond Forum
Fund values tend to be less stable
Q
I understand that when buying individual municipal bonds, I need to be aware that bond prices drop when interest rates rise. However, it occurs to me that the situation might be different for a municipal bond fund. In that case, wouldn’t the fund be buying new bonds as old bonds are retired? Therefore, it seems to me that the net effect would be for the bond fund price to remain relatively constant. Do I have that right or am I missing something?
A
James A. Klotz responds:
Your theory is good, but you are missing something: Bond funds that offer yields equivalent to long-term bonds can only do so because their holdings are made up of long-term bonds.In other words, they don’t have bonds coming due all the time, as you suggest.
Long-term bond funds do not perform better in the marketplace than long-term bonds because they are burdened with sales charges and ongoing management fees, and have no stated maturity dates. For these reasons, fund values tend to be less stable, particularly during periods when redemptions outstrip sales (more sellers than buyers).
There are short-term funds that perform in the manner you suggest, but so do short-term bonds. Although these short-term funds and bonds are much less volatile, they do not maximize tax-free income, which is the main reason that most investors buy municipal bonds.
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