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What are the pros and cons of investing in bonds directly versus using a bond mutual fund?

With a bond mutual fund, you're paying an on-going fee to have a professional manager decide what bonds to buy and sell, and when. This cost is reflected in the annual management expense ratio (MER) you pay if you own the fund.

A good bond fund manager may add value that more than offsets this ongoing cost. The manager may, for example, try to anticipate interest rates in order to boost returns. If interest rates are high and expected to fall, the manager may load up on long-term bonds in order to generate a capital gain when interest rates fall. If rates are low and expected to rise, the manager may increase the weighting in short-term bonds in order to minimize capital losses. If you feel that a bond fund manager may do a better job managing the bonds than you would, a bond fund may suit you. You might prefer to leave the bond management to a fund manager because you don't have the knowledge, time and interest to do it yourself. Another alternative is to hold individual bonds, and work with a full-service broker who would recommend what bonds to buy and sell. Your broker would be paid a commission every time you bought or sold a bond.

Reasons, other than professional management, for why you might want to use actively managed bond funds:

Rather than buy an actively managed bond fund, you might want to use a passively managed index bond fund. These funds buy and hold a selection of bonds. They merely try to match the returns of a bond index. Less buying and selling of bonds by the fund translates into lower MER costs for you.

Reasons why you might want to hold bonds directly:

Consider getting professional investment advice.