Why target-maturity bond funds aren't for everyone

These vehicles offer simplicity and predictability, but there are criticisms and drawbacks to using them

Why target-maturity bond funds aren't for everyone

Target-maturity bond funds, not to be confused with target-date funds, have gained the attention of certain investors. But while they confer certain advantages, they also come with drawbacks that must be considered.

Unlike other bond funds that constantly buy and sell individual bonds, target-maturity bond funds let investors know when they should expect their investment to mature, which confers some peace of mind as they wait out a downturn. This is especially useful for those who need steady income and a return of principal for an expected need like paying for college, starting retirement, or buying a home, reported the Wall Street Journal.

“It takes the volatility and randomness out of the equation and, most importantly, takes out the investor’s emotional reactions to the stock-market gyrations,” Jay Srivatsa, chief executive officer at California-based Future Wealth, told the Journal. “Knowing that X amount will be available on year X gives peace of mind.”

Srivatsa said target-maturity funds are easier to research and purchase than individual bonds, and they are attractive to those who want to avoid long-term interest-rate risk. And according to Ankur Patel, vice president at the New York office of Lenox Wealth Advisors, older investors may find that the option is worth considering.

“As we continue to see baby boomers enter retirement, an entire generation of investors will be looking to reduce risk, generate income and invest more in bonds,” Patel said.

But Debra Taylor, founder of New Jersey-based wealth-management firm Taylor Financial Group, noted that they have significantly higher annual costs than index bond funds for buy-and-hold investment.

“[T]hey do provide diversification for the smaller investor … However, the more-sophisticated investor may be better off purchasing the individual bonds and creating their own ladders,” she said. The funds would be ill-suited to young people with long investing horizons, she added, as their maturity dates go out to only 10 years.

Other experts agree that the vehicles aren’t ideal for those with plans to reinvest. The principal may be returned when yields are low, or other inconvenient times for reinvestment. And the fund yield can’t be expected to rise because of rate increases because a target-maturity fund won’t replace its holdings.

Dennis Shirshikov, a financial analyst at FitSmallBusiness.com in New York, said that many bonds held by such funds will mature months before the fund closes, leaving idle cash. Patel also advised investors to expect fund yields to drop to the level of bank savings in the fund’s final year. The problem of cash buildup even before maturity is worsened when a fund owns bonds that can be called early.

If an investor chooses to unload a fund before maturity during a time of rising rates, they also stand to lose money. “These are generally not a great short-term trading option,” Shirshikov said. “In fact, you will likely be better served with other bond products if you are interested in trading on bond volatility or interest-rate movements.”


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