3

Looking at a bond index fund Key Investor Information, I have found this:

Income from the Fund will be reinvested and reflected in the price of shares in the Fund

I don't fully understand it. As far as I understand, the point of bonds is that they are fixed income assets (they provide a fixed income on a yearly/monthly basis), so if the income is reinvested, this property is not applicable to bond index funds, right?

They provide nothing unless you're able to sell for a higher price than you bought, is this correct? If so, what is the difference with an index fund?

EDIT

After investigating a bit more (see https://www.fidelity.com/learning-center/investment-products/mutual-funds/bond-vs-bond-funds ), as far as I can see, there is no difference between stock funds and bond funds (if they both reinvest dividends/income) with regards to the fixed income feature. Neither of them will yield any benefit on a monthly/yearly basis (unless you manage to sell them for more than you bought them)

I assume that the quote above (reinvestment being reflected in the price of the shares) means that the fund's NAV will get bigger because of such reinvestment, so in the end, you will get all that reinvested income when you sell because it is included in the sale price. Is this correct?

If so, how is that bond index funds are 'safer' than stock index funds?

2
  • You seem to be repeatedly confusing things which are actually different first fixed income vs reinvestment, now fixed income vs volatility. Have you thought of getting a good book like "Common Sense On Mutual Funds" and just reading it through? – Harper - Reinstate Monica Jan 11 '20 at 8:51
  • 1
    Fixed income is the kind of asset the fund invests in. – chrylis -cautiouslyoptimistic- Jan 11 '20 at 11:32
8

No, you are not quite correct.

Assume you have a simple bond that costs you $100. There are 2 ways the bond provides you money: It might provide you with interest every month/quarter/year, or it might provide you with a future repayment of, say $105. Either way, this bond would be considered 'fixed income' because the value you receive is not based on external factors, like profitability of the underlying company.

Now assume that you have 10 bonds costing you a total of $1,000, that each pay you $10 every year. Every year, you get $100. That $100 is enough to buy a new bond. So you do this yourself, manually taking your interest received, and reinvesting it by buying new bonds. Next year, you would have 11 bonds, costing a total of $1,100, each paying you $10 every year, so every year you get $110. Repeat ad infinitum.

Now imagine if you were a fund manager with the above situation. Imagine I paid you $50 for 5% of your 'bond fund', and your bond fund pays me $5 every year for my cut of the income. If you take that $5 for me on my behalf, and simply give me an extra small % of the value of your bond fund, you have the mechanics you are describing.

At no point in the above example did the underlying nature of the fixed income assets change - just how convenient you made it for me to keep reinvesting my interest.

5

I think you're taking "fixed income" a bit too literally. They are funds that consist of fixed-income investments.

They provide nothing unless you're able to sell for a higher price than you bought, is this correct?

When the interest is re-invested, the total value of the fund will increase. So the fund will grow by reinvesting the coupons (all else being equal).

Suppose the fund only had one bond worth $1,000 (par) that paid a 10% annual coupon. If interest rates did not change, In one year the bond would still have a value of $1,000 but you'd have bought another $100 of them, so the value of the fund would be $1,100.

how is that bond index funds are 'safer' than stock index funds?

They are "safer" in the sense that bond funds have lower risk than equity funds in general, since they consist of lower-risk investments (bonds vs. stocks).

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.