Bond Index Funds-a Synopsis                          Page 8

Diversification

A rarely-noted advantage of bond index funds is that they are frequently more diversified than actively-managed bond funds. An index that follows the Lehman Brothers Aggregate Bond Index, as most bond index funds do, will hold a wide variety of government and corporate bonds and mortgage-backed securities, which is usually not the case with actively-managed funds, where managers often favor the more liquid issues. Even within the bond index fund subcategory of bond funds, there is substantial variance in the funds' breadth of participation. Perhaps the best fund as far as this kind of breadth is concerned, is Vanguard's Total Bond Market Index, which includes every possible maturity and sector of bonds, except junk, so no matter what sector rallies, this fund will participate.

Advantages of Bond Index Funds Over Buying Bonds Directly

* Bigger is better in Bonds There are numerous benefits to being very well-capitalized when buying bonds, including volume discounts and invitations to closed auctions. Ordinary investors can rarely take advantage of these benefits.

* Lower Investment Amounts The minimum investment for an individual bond can be as high as $10k. Realistically it probably takes about $50k to build a diversified and cost-effective portfolio of bonds. On the other hand, the minimum investment in a bond index fund is usually $500 or $1000. And a mutual fund investor can often buy addition fund shares in increments as low as about $10.

* Regular Monthly Income Most bond index funds distribute dividends monthly. Investors may choose to receive them as cash or have them automatically reinvested. Individual bonds usually pay interest only every six months and these payments cannot be reinvested automatically. This is often an important consideration, especially for retirees.

* Even "passive" bond index funds enjoy the benefits of fixed-income analysts; Vanguard has six such analysts who decide which bonds to buy and sell for their index funds and actively-managed funds. These analysts are important because few investors have the time or the expertise to manage their personal investments or to investigate all the different bonds on the market. And investors often underestimate the complexity of global fixed-income securities markets.
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