Understanding Inverse Bond Funds

Bond funds are a legitimate way to get involved in the bond market without actually buying or selling bonds. A variation of the bond fund is the inverse bond fund. Here are the basics of the inverse bond fund and how they work. 

What Is a Bond Fund?

In order to understand well what an inverse bond fund is, you first need to understand what a bond fund is. A bond is a debt instrument that is issued by a company, municipality or government. Investors can lend a certain amount of money to this entity in return for a regular interest payment. The entity pays the interest and then, at the end of the term, returns the investor's original investment. 

A bond fund is like a mutual fund that uses bonds as the underlying assets. The fund managers buy and sell bonds and then sell shares in the fund to investors. Therefore, by investing in a bond fund, you can take advantage of the bond market without actually knowing that much about it. It is a form of "hands off" investment that handles all of the investment decisions for you. 

With an inverse bond fund, you are still investing in the bond market. However, you are betting that the value of certain bonds will go down. Unlike with other traditional forms of investment, you want to see the price for bonds go down. 

Through the selling of long-term bonds, inverse bond funds benefit from bond prices' going down. Fund managers take the money from the sales and invest it into short-term bonds that are usually at a lower yield than what the long-term bonds had. 

Investment Considerations

An inverse bond fund rises in value when the value of the bonds goes down. A bond's value depends on the interest rate in the market. If interest rates rise, then bond values go down. For example, let's say that you bought a $1000 bond that pays an interest rate of 5 percent. If the interest rate in the market went up to 8 percent, the value of your bond would go down. An investor would not be willing to pay a full $1000 for the bond, and therefore, the face value of the bond would decrease. This means that you would invest in an inverse bond fund because you are expecting market interest rates to rise. 

When you invest in this type of fund, be prepared for larger fees. Inverse bond funds usually have higher fees than other types of bond funds, and the minimum to get involved is often much larger than normal. You could find a minimum amount of $15,000 to get involved. 

Timing

When you are investing in inverse bond funds, the timing of the investment is critical. Over the long term, inverse bond funds are not a good idea. Over time, the value of bonds tends to increase. Therefore, if you use this as a long-term investment strategy, you will ultimately be disappointed. However, if you get in and get out at the right time, you could stand to make a nice return on your investment.

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