Bond Fund Valuations

Q: Looking up the value of the bond funds SMI recommends, it looks as if they've barely changed in value for years. Why would I want to buy a fund that hasn't gone up in years?

A: Bond funds and stock funds enrich their shareholders differently, and that can be confusing. Stock funds generally produce gains by having their daily prices, or Net Asset Values, go up over time. While stock funds do distribute some dividends and capital gains, this isn't their primary means of producing gains for you. Instead, you hope to sell a stock fund at a higher price than you bought it. In this respect, stock funds are similar to individual stocks.

On the other hand, with bond funds your gains don't come primarily from appreciation in the price of the fund. While that can happen, it's more common to see a situation similar to that of our recommended Vanguard Short-Term Bond Index, whose share price has bounced between $9.60 and $10.50 for the past eight years. With most bond funds your gains come from the regular healthy dividends paid by the fund. Bond funds typically pay monthly distributions to shareholders. Since the dividends are paid out of the assets of the fund, these payouts reduce the price of each share and make it look like gains have been slight. But if you reinvest those dividends you'll find that while the price of your shares stays roughly the same over time, each month you're accumulating more shares by those reinvested dividends. Reinvested or not, you're making a better profit in bond funds than the share price alone indicates.

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