Bonds vs Mutual Funds
Mutual funds and exchange-traded funds are not investments, in the sense that a stock or a bond is. Stocks and bonds are asset classes. Mutual funds and ETFs are pooled investment vehicles, where the money of a number of investors is taken together to buy large blocks or large collections of securities.
What is a Bond?
Just like companies require funds to expand their operations, the government too requires funds for various things like social programs, infrastructure building, etc. For a private company as well as a government organization, the funds required are usually far more in volume than what a bank can provide. Hence, they issue bonds in the public market to raise funds. Therefore, a bond is similar to a loan which thousands of investors give to a company which is in need of capital. In other words, a bond is a debt instrument which a company or the government issues in order to raise capital where the investor is the lender and the company issuing the bond is the borrower.
When an investor purchases a bond, they are lending their money to the company or the government. In return for the money lent, the issuer of the bond will pay a certain amount of interest on the money, which will be returned to the investor at a specified date in the future.
Stocks, on the other hand, do not offer interest but offer ownership in exchange for the borrowed sum. Companies that issue stocks are giving investors the chance to own a part of the company in return for cash. Stocks are issued primarily for 2 reasons – to raise capital and to compensate the early investors and owners. Companies prefer selling a part of their stocks rather than take a loan and be in debt.
Mutual Funds
A Mutual Fund (MF) is an investment tool that invests in stocks, bonds, or cash equivalents. A large sum of money is consolidated and invested in varied securities like shares, bonds, and other assets. Mutual Funds are managed by experienced professionals known as a fund managers. Mutual funds not only provide you with fund management expertise but also allow you to diversify your portfolio in order to meet your financial goals.
Mutual funds give an opportunity to small or independent investors to access professionally managed portfolios consisting of bonds, equities, and other securities. The gains and losses of the fund are shared proportionally among all shareholders. The performance of an MF is derived by summing up the performance of the underlying assets.
All MFs are registered with the Securities and Exchange Board of India (SEBI) which also acts as a regulator of these funds.
What are the differences between mutual funds and bonds?
By owning individual bonds, you control which bonds you like enough to buy. You pick and choose the bonds you desire, when to buy and sell each of them (if at all), and you are limited by the bonds that happen to be publicly traded.
You, as a bondholder, also have more of a say in how a company distributes its assets in case it goes bankrupt. Stockholders have virtually no say.
With a mutual fund, you choose the general bond purchase strategy that you desire, and let the mutual fund managers decide how to execute that overall strategy, using their expertise to make bond purchases.
While the managers pick the bonds they believe are right for the fund, you have no say in the matter. You are relying on their expertise.
So, while you theoretically own bonds from many different companies, you in fact own a chunk of a fund, which in turn owns those bonds.