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Investing Specialists

Don't Overlook the Risks of Individual Bonds

High transaction costs, lack of flexibility, and credit-quality risk loom large.

It's a question that I've gotten a lot over the past few years, and it's a good one: If you're concerned about the prospect of rising interest rates crunching your bond fund, why not opt for individual bonds and hold them until maturity? Provided you purchase a bond from a creditworthy issuer, you can simply collect your income stream and then get your principal back when the bond matures, regardless of the interest-rate climate.

Bond-fund holders, by contrast, won't necessarily be assured a return of their principal, and the interest they receive from their bond funds could also fluctuate. The crucial difference is that the bond-fund manager, like a stock-fund manager, is overseeing a basket of securities whose value must be tallied each day; that value depends on the price of each of the securities in the portfolio at the end of that day. That means that the value of the portfolio could change even if the manager doesn't do a thing; the manager can also sell bonds prior to their maturity at a higher or lower price than what he paid.