Bonds vs. Bond Funds: How Higher Rates Are Changing the Calculation

livemint.com:

how to decide between bonds or funds: Bond investors often share a sentiment credited to Mark Twain, that the return of their money is more important than the return on their money. For that reason, many prefer buying individual bonds and holding them until they mature. That way, it doesn’t matter what happens to the price of the bond in the meantime—investors can lock in today’s rate and generally expect to get back what they put in.

A bond is effectively an investor lending money to the federal, state or local government, or a company. The borrower makes interest payments, usually in twice-yearly fixed amounts, until the time the issuer pays back the principal. Investors can buy corporate or municipal bonds through an online brokerage account.

Treasurys are also available through brokers or online from the government through TreasuryDirect. The risk of buying them a la carte comes from concentration. If a company runs into trouble and defaults on its debt, bondholders can suffer steep losses.

Even local governments, generally safe, sometimes miss interest payments. Funds, in contrast, mitigate that threat. They hold thousands of bonds at the same time, so the occasional default isn’t that big a deal.

But the price of those funds rises and falls with rates—and getting your principal back requires selling the fund. Consider how an investor who put $10,000 in California municipal bond mutual funds in March 2022 would fare relative to someone who bought $10,000 worth of one-year California state bonds on sale that month with a yield of 0.94%. The bondholder would get back his $10,000 plus payments of $47 at the six-month and one-year marks, netting perhaps $84 after brokerage costs.