Individual Bonds Versus Bond Funds

This choice generates more confused advice than any other in fixed income, usually resting on a claim that is simply false: that when a bond fund faces redemptions it must “fire-sale” holdings and pass locked-in losses to the investors who stayed. A mutual fund transacts at net asset value, and the departing investor receives the same marked-down price the remaining ones already carry. Redemptions can widen trading costs in genuinely illiquid corners of the market — high-yield during a panic, obscure municipals — but in Treasuries and broad investment-grade paper this effect is trivial and it is not the reason to prefer one structure over the other.

The real difference is the maturity date, and it matters. An individual bond held to maturity pays par on a known day regardless of what happened to its price in between; the interim mark is information you can ignore if the money is not needed until then. A fund has no maturity. It holds a rolling portfolio at a roughly constant duration, so a rate shock produces a drawdown that is recovered not by a contractual payment on a date but by reinvesting at the new higher yields over roughly the fund’s duration. Both end up in a similar place — the arithmetic of duration is indifferent to the wrapper — but only one of them lets you name the date.

That points to a clean division of labour. Where a bond is funding a specific liability on a specific date — a tuition payment, a tax bill (section “Sinking Funds for Known Lumps”), a retirement year in a TIPS ladder (section “TIPS Ladder as a Withdrawal Strategy”) — buy the individual security and match the maturity to the need. Where the bond sleeve exists to dampen portfolio volatility and rebalance against equities, with no date attached, the fund’s diversification, automatic reinvestment, and daily liquidity are worth more than a maturity you were never going to use. Treasuries make the individual-bond route cheap, since they trade at negligible spread and carry no ongoing expense ratio; corporate and municipal bonds bought in retail size do not, and there the fund almost always wins on execution alone.