What Are Intermediate-Term Bond Funds?

Definition and Examples of Intermediate-Term Bond Funds

Intermediate-term bond funds invest in bonds that offer investors a five- to ten-year turnaround. Mutual funds pool money from many investors and invest it with a specific goal or investment type in mind. They tend to be easier to buy than individual bonds because the fund managers do the research for you. The minimum amount needed to invest is also usually lower.

With a bond fund, you diversify your holdings, and you may be invested in a lot of different types of bonds—government, corporate investment-grade, corporate high-yield, municipals, for example—which minimizes the risk of default wiping out all of your assets. Intermediate-term bond funds are no different and will provide you with diversification within that bond fund class.

Maintaining a diversified mix of investments from different asset classes is an important element of any investment plan. That is why it is important to monitor your total asset allocation mix across all investment asset classes. Investment decisions should always be made with consideration to your time horizon and risk tolerance.

How Intermediate-Term Bond Funds Work

Bonds have maturity dates—which is when the bond issuer pays back the principal or face value of the bond—that can range from less than one year to several decades. Breaking down this range into smaller time periods makes it easier for investors to determine how certain bonds align with their investment strategy and financial goals. Ranges are generally defined as:

• Short-term: Less than one year to five years
• Intermediate-term: Five to ten years
• Long-term: Ten years or longer

Short-term bonds offer less interest rate risk than long-term bonds, but they're often thought of as an alternative to money market funds with their relatively low returns. When interest rates rise, the price of an existing bond goes down, because investors would get a higher return by buying a new bond that pays higher interest.

When interest rates are uncertain, staying in the intermediate-term can be a happy medium. That's because you'd take on less interest rate risk than you would with a long-term bond while getting a slightly better return than you might from a short-term bond.

Fees are one of the most critical factors when choosing a mutual fund. The average domestic bond fund has an expense ratio around 0.42%, but you may find a bond index fund that's even less costly. More importantly, look for a no-load fund. Loads are additional commissions or expenses that you may pay at the front-end when you first buy the bond, or on the back-end once you sell.

Pros and Cons of Intermediate-Term Bond Funds

Pros Explained

• Less work for the investor: When investing in an intermediate-term bond fund, you eliminate a lot of the work that goes into researching individual companies, their financial health, and the value of the investment. When deciding to invest in a bond fund, the only research needed is information about the fund itself, not necessarily the fund's individual companies.
• Automatic diversification: Not only is diversification important in regards to investment type, but it's also important to have within asset classes. Investing in intermediate-term bond funds gives you instant diversification by spreading the investment over various company types and bond risks.

Cons Explained

• Lower returns compared to stocks: While bonds are generally considered safer investments than stocks, they also offer much lower returns. If you're younger and want to focus on growing your portfolio instead of capital preservation, bonds may not offer high enough returns to satisfy you.
• Inflation risk: Inflation happens when the purchasing value of the dollar drops. With bonds offering low returns, there's a chance that the bond's interest rate doesn't keep up with the rate of inflation. If your bond offers 1%, but inflation rises by 2%, your purchasing power decreases.