Can a Bond Fund Lose Money? Three Risks to Read First

A bond fund pools investments primarily in bonds or other debt securities. It can be a mutual fund, exchange-traded fund or another investment-company structure. The word bond does not mean your original investment is guaranteed to remain intact.

What does the fund actually own?

Investor.gov explains that bond funds can hold government, municipal, corporate or other types of debt, or a mixture. The holdings differ in maturity, risk and other features. Two funds with income in their names can therefore have very different exposures.

Begin with the investment objective and holdings. Read the prospectus and most recent shareholder report rather than using the fund's name as the entire description. Ask which issuers and debt structures contribute to the result.

How can interest rates or defaults hurt?

Credit risk is the chance that an issuer fails to pay what it owes. If a fund owns that issuer's bonds, the default can affect the fund. A mix of holdings does not eliminate this risk.

Interest-rate risk is different. When interest rates rise, the market value of bonds held by a fund generally falls. Investor.gov notes that longer-maturity holdings generally face more of this risk. Even a fund investing only in U.S. government bonds can lose money because of rate changes.

What is prepayment risk?

An issuer may repay debt early, for example after rates fall. The fund may then have to reinvest the proceeds at a lower return. That can change the income opportunity without requiring the issuer to default.

Review these risks together with fees and the time when you expect to need the money. Do not treat a bond fund as a bank deposit or assume that a displayed distribution rate guarantees future income. Investments can lose value, including principal.

Frequently asked questions

Can a government-bond fund lose value? Yes. Investor.gov identifies interest-rate risk even for funds holding only government bonds.

Does a lower-risk label replace the prospectus? No. Check the actual holdings, strategy and disclosed risks before investing.

Sources and further reading: Investor.gov, Bond Funds and Income Funds (https://www.investor.gov/introduction-investing/investing-basics/glossary/bond-funds-and-income-funds).