Bonds: The Unbeaten Path to Secure Investment Growth

Chapter 16. CHOOSING A BOND FUND

THE INFORMATION RESOURCES on the Internet are a great boon to investors seeking to narrow down their fund choices. Before undertaking a search, however, it's important to determine what kind of investor you are or want to be. Do you want to engage in the thrills of trading, always hoping to be one profitable step ahead of the market, or do you want to simply buy and hold bond funds and get on with the rest of your life? We call the former an active investor and the latter a passive investor. An active investor seeks out actively managed total-return funds or no-load funds. The pitfalls of this strategy are potential loss of capital, higher expenses, and short-term capital gains that may be taxed as ordinary income. The passive investor seeks out and holds no-load index funds in order to pay minimal fees and negligible taxes.

You also need to consider your tax status. If you're in a high tax bracket and want to generate tax-free interest income, you may want to have municipal bond funds in your portfolio. If you're subject to the AMT, check out whether the funds buy municipal bonds subject to the AMT. If a fund holds taxable bonds, your income will be currently taxable, unless the funds are held in a tax-sheltered retirement account. Income dividends from non-AMT municipal bond funds will be exempt from federal tax but may be subject to state and local income taxes, depending on the laws of your state affecting income from municipal bonds.

In choosing ...