Last week, I introduced to you what a money market fund is and the techniques for purchasing money market funds. Following the order from low to high risk of funds, today I will introduce another type of fund—bond funds.

Compared to the money market funds introduced previously, bond funds offer slightly higher returns but also come with a bit more risk.

So, how do you choose a good bond fund, and what should you pay special attention to?

This article will provide a detailed introduction.

1. What is a bond? What is a bond fund?

A bond, in simple terms, is a "promissory note."

For example, if a neighbor borrows 30,000 from you, and you give them a promissory note, agreeing on a certain interest rate, to be repaid after one year, this is a debt relationship between individuals.

However, if a country borrows money from you and gives you a debt certificate, it can be called a government bond. Because the credit of the country is the best, the risk you bear is very small, so the returns you can get will not be too high.Additionally, the IOU between you and your neighbor can only be used personally between you two and cannot be circulated between individuals and businesses, banks, etc. However, government bonds, corporate bonds, and financial bonds, because they are standardized IOUs issued after being approved by various national departments in a format required by the state, can be circulated in the market. For example, if you take a bond from the China Development Bank to the bank to offset a debt, the bank will accept it.

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So, how should we understand bond funds?

According to the classification standards of fund categories by the China Securities Regulatory Commission, a fund that invests more than 80% of its assets in bonds is considered a bond fund. However, due to different investment scopes, bond funds are roughly divided into two major categories.

One category is pure bond funds.

The other is hybrid bond funds.

Among them, pure bonds are further divided into short-term pure bonds and medium to long-term pure bonds based on the difference in duration (also known as the continuation period). Hybrid funds can be divided into primary bond funds, secondary bond funds, and convertible bond funds.Next, let's introduce them one by one:

Pure Bond Funds

So-called pure bond funds refer to those that invest 100% in bonds, with no proportion invested in the stock market. Therefore, the risk of purchasing pure bond funds is not very high; its greatest risk is not keeping up with the pace of inflation.

Among them, short-term pure bonds refer to investments in bonds that mostly mature within one year, while medium to long-term pure bonds refer to bonds that mostly mature within 1-5 years.

Primary Bond Funds

In layman's terms, these are fund products that primarily invest in bonds, do not participate in secondary market stock trading, but have up to 20% of their positions that can participate in initial public offerings (IPOs).

The risk of this type of bond fund is higher than that of pure bond funds and lower than that of secondary bond funds; the expected return is higher than that of pure bond funds and lower than that of secondary bond funds.

Secondary Bond Funds

In addition to mainly investing in bonds, they also invest a small portion in stocks to seek a higher overall return. The risk is higher than that of pure bond funds and primary bond funds, and of course, the expected return is also higher.

Convertible Bond FundsAllowing the conversion of purchased bonds into company stocks, these funds are closely linked to the stock market, hence they are considered to have a higher risk among bond funds.

It is evident that different bond funds carry varying degrees of risk and returns, and the types of investors they are suitable for will certainly differ.

II. What are the characteristics of bond funds?

Those who are familiar with bonds might wonder, since bond funds primarily invest in bonds, why shouldn't I just buy bonds directly?

Most people who think this way are likely not fully aware of the characteristics of bond funds.

Generally, the way we purchase bonds is through bank counters and exchanges. For example, when buying government bonds, one needs to go to the bank counter on the purchase date, and often it is a situation where "one bond is hard to find."

Moreover, these bonds can only be redeemed with principal and interest upon maturity, which means they have poor liquidity.

If purchased through exchange channels, it is usually done through a securities company's stock account, but this requires a higher level of personal expertise.

For instance, one needs to analyze the bond market trends, look at credit ratings, industry development prospects, and the basic situation of the company, etc. Without professional expertise, blindly entering the market could lead to losses.

However, if everyone invests in bonds by purchasing bond funds, the above two issues will not exist.On the one hand, when you invest in bond funds, the fund company has a professional team that researches various bond types in the market, and the range of bond investments is broader, which can achieve the purpose of risk diversification.

On the other hand, bond funds can be redeemed at any time, offering good liquidity. Looking at the past performance of bond funds, excellent bond funds can even match equity-oriented funds, but with much less volatility.

So, I personally highly recommend participating in bond investments indirectly by purchasing bond funds.

III. Three Points to Note When Purchasing Bond Funds

1. Bond funds are not guaranteed to preserve principal.

Many people believe that when they buy bond funds, they can get their principal back and receive returns upon maturity. However, in reality, bond funds do not guarantee the preservation of principal.

The risks of investing in bond funds mainly come from two aspects: default risk and interest rate risk.

Default risk:

In simple terms, default risk means that a country or company cannot repay the money they borrowed from you.

Of course, if you purchase government bonds, the risk of default is almost non-existent; but if you purchase corporate bonds or financial bonds, there is no 100% guarantee.Interest Rate Risk:

Bond prices have an inverse relationship with market interest rates. When the supply of funds tightens and market interest rates rise, the prices of bonds will decrease. The most direct consequence of this is that as interest rates increase, the bonds that have already been purchased will "depreciate," meaning that the returns on bond funds will decrease.

2. Conduct a Risk Assessment:

This point needs no elaboration. When we invest in any product, we should first clarify our goals, whether we are pursuing low-risk, stable returns or relatively higher returns, etc. Next, based on our own risk tolerance, we should choose the appropriate type of bond fund. Here is a simple ranking of the risk levels of these bond funds from low to high: pure bond funds < primary bond funds < secondary bond funds < convertible bonds, for your reference.

3. Pay Attention to the Fee Structure:

The subscription fee for bond funds is generally 0.8%, which is lower than the 1.5% for hybrid funds and equity funds. The same bond fund may have three categories: A, B, and C, representing three different fee structures:A-class bond funds represent front-end charging (where the subscription fee is deducted directly at the time of purchase);

B-class bond funds represent back-end charging (where the subscription fee is not deducted at the time of purchase, but is deducted when redeeming);

C-class bond funds represent no subscription fee but have a sales service fee.

When buying bond funds, it is more cost-effective to choose the charging method based on the length of time you plan to hold:

If it's a short-term investment (1-2 years), you should choose C-class bond funds; if it's a long-term hold (more than 3 years), then you can choose B-class bond funds; if you're unsure about the investment duration, then choose A-class.

IV. Which investors are suitable for buying bond funds?

1. Investors with low risk tolerance and a pursuit of stability

As can be seen from the figure below, over a decade, equity funds have been volatile with significant ups and downs, while bond funds have grown steadily with less volatility.

Therefore, if you do not want to bear the high risk of significant fluctuations and are pursuing a higher return than money market funds, bond funds are a good choice.2. Friends who want to make short-term investments

Bond funds have relatively low risk fluctuations, and their long-term returns are better than bank savings, making them very suitable for managing our spare money.

Therefore, for those who have some spare money but do not want to make plans for decades or even longer, such as parents whose children are already in high school and want to prepare a college education fund, investing this money in bond funds for short-term investment is a very good choice.

So, when is the best time to buy bond funds? Here are two suggestions for everyone's reference:

1. When the stock market starts to bear:

Generally speaking, when the stock market is not doing well, the bond market will welcome a good performance. Therefore, when a bear market is encountered, bond funds will have certain performance, and this is the best time.

2. When interest rates are cut and the reserve requirement ratio is lowered:

As mentioned earlier, when market interest rates rise, bond prices will fall; conversely, when market interest rates fall, bond prices will rise.

Therefore, when there is an expectation of a loose monetary policy, and when there are expectations of interest rate cuts and reserve requirement ratio cuts, everyone can seize this opportunity to invest.

In summaryOverall, bond funds are considered to be relatively moderate in terms of risk and return among the varieties of funds. If you can tolerate a higher level of risk than investing in money market funds and are looking to pursue higher returns, investing in bond funds is a very wise choice. All investments carry risks, and the discussions today are for educational purposes only and should not be taken as investment advice.