Why do Bond Fund Prices Vary?

by dd on Apr.10, 2009, under Fixed Income

Why DO bond mutual funds vary in price?

Individual Bonds

Individual bonds, when held to maturity, give you the principal, not necessarily the purchase price, back plus interest. Typically, a bond is initially sold for $1,000 which is the principal amount. Existing bonds can be purchased through brokers in the secondary market. The purchase price of these bonds can be higher or lower than the principal amount. If you priced an individual bond every day as to what it would sell for, most likely it will vary from its issue price, but you will get your principal back at maturity date (or call date, if that occurs) as long as the company does not go bankrupt.

Bond Funds

Bond funds do not have a maturity date. The portfolio is priced every day, after market close, to see how much it is worth if it sold all its holdings. Depending on the risk of the bonds bought, the price of the bond fund can vary quite a bit (measured by standard deviation). Short-term bond funds will vary much less than long-term bond funds.

To give you a feel for standard deviation, a short-term bond fund such as VFSTX (Vanguard short-term investment grade fund) has a SD about 3. FAGIX (Fidelity’s Capital & Income fund), a junk bond fund, has a SD around12.

Standard deviation and monthly prices can be found on finance.yahoo.com under risk and historical prices.

The riskier the bond fund the higher the standard deviation and the more the prices vary.