Selecting Bonds and Bond Funds, and Setting Your Rules

Turning everything you know into a purchase

This unit has been building toward one moment: money in the account, and a decision about where it goes.

You already have the pieces. You know a bond is a loan you make to a government or a company, paying interest along the way and returning par value — the amount repaid at the end, usually $1,000 — at maturity. You know why the price moves opposite the yield, what duration measures, and how credit risk and interest-rate risk differ. You've seen a bond ladder — bonds bought with staggered maturity dates so something is always coming due — and formed a view on maturities.

None of that tells you which bond to buy. This lesson does that, and then writes the rules that govern what happens after.

What you actually look at on an individual bond

Most brokers offer a bond screener — a search tool that filters the bonds available to buy by criteria you set. Some are simple lists with filters; some walk you through questions and hand back a proposed set. They differ, and none of that matters much, because the tool isn't the skill. Knowing what to type into it is.

The screener will ask you for some version of these: how much you have to invest, when you want payments to start, how long you're willing to lock money up, and how much credit risk you'll accept. Those aren't new questions. You answered every one of them when you set your allocation and decided the shape of your ladder. Your plan is the input.

What comes back is a list of specific bonds. Here is what to read on each one, and why.

The issuer. Who owes you the money — the U.S. government, a state or city, or a company. This is the single biggest driver of everything else on the list. A Treasury and a corporate bond of the same length are not the same instrument with different numbers; they're different promises.

The credit rating. An agency's opinion of whether the issuer can pay you back. An opinion — informed, published, and sometimes wrong. Investment grade means the agencies see lower credit risk. A high-yield bond is rated below that and pays more precisely because more can go wrong. If a bond's yield jumps out from everything around it, the rating usually explains why, and the extra yield is the price of a risk somebody else declined to take.

The maturity date. When you get your par value back. This is the number that decides which rung of your ladder the bond fills, and it's also the number that decides how much the price will move if rates change. Longer maturity, more sensitivity.

The coupon. The interest rate the bond pays on its par value. Notice this is not what you earn — it's what the bond pays, calculated on $1,000, regardless of what you paid for it.

The price. Quoted against par. Above par is a premium; below par is a discount. A bond trading at a premium is not a worse deal and a discount is not a bargain — the price is the market's adjustment that makes an old coupon compete with today's rates. It already accounts for itself.

The yield to maturity (YTM). The one number that ties the other four together: what you'd actually earn per year if you bought at today's price and held to maturity, counting both the coupons and the gap between what you paid and the par value you'll get back. Coupon tells you what the bond pays. YTM tells you what you make. When you compare two bonds, this is the column to compare.

Whether it's callable. A callable bond lets the issuer pay you back early, at a time the issuer chooses. Read that again, because the asymmetry is the point: an issuer calls a bond when it can borrow more cheaply elsewhere — which is when rates have fallen — and rates falling is exactly when your above-market coupon has become valuable. The bond gets taken away at the moment you'd most want to keep it, and you're handed cash to reinvest at the new, lower rates. Nobody calls a bond to do you a favor. A callable bond usually pays a bit more up front, and that extra is what you're being paid for handing the issuer that option.

Choosing among what survives

Once you've filtered down to bonds that meet your risk criteria and fill the maturities your ladder needs, the sorting rule is simple: among bonds that clear your risk bar, prefer the higher yield to maturity. The risk criteria come first and do the real work. Yield only breaks ties among bonds you'd already be willing to own.

One tiebreaker sits underneath that. Individual bonds pay interest on fixed dates — usually twice a year, on dates set by the issuer, not by you. If you decided earlier in this course that you want income arriving evenly through the year, then payment dates are worth checking before you buy, because you can't adjust them afterward. For most people yield matters more than which months the money lands in. If it doesn't for you, the time to fix it is now.

What you actually look at on a bond fund

A bond fund holds many bonds at once, and the evaluation genuinely changes — not because funds are simpler, but because the things you just checked either don't exist or exist as averages.

There's no maturity date, because there's no single bond. The fund buys and sells continuously; bonds inside it mature and get replaced. A sibling lesson made the consequence explicit, and it's the difference that matters most: nothing brings your principal back to par on a date. You get whatever the shares are worth when you sell them. That isn't a flaw — it's what you trade away in exchange for owning hundreds of bonds with one purchase.

So the columns change:

Read the last row twice. It's the one criterion with no counterpart on the left, and it's permanent.

Working the fund list

Start with what it holds, not what it's called. Fund names are a hint and nothing more. Something called "XYZ Short-Term Treasury Fund" probably does hold short-term Treasuries, and "probably" is not a basis for a decision. The prospectus — the fund's official disclosure document, listing objectives, holdings, and costs — is where you find out. It's not fun reading. It is the only place the answer actually lives.

Watch what a rating on the fund does and doesn't tell you. Funds often carry a third-party rating of their own. That's an assessment of the fund — its record, its process, its cost — not a credit rating. You set your risk tolerance in terms of the credit ratings of individual bonds, so the honest check is to look through to the holdings and their ratings, not to accept the fund's own grade as an answer to a question it isn't answering.

Then yield, as a starting filter. Since you can't compare maturity dates, yield is the practical way to narrow a field of funds that already match your objectives. Look for better than the average yield in the category you're shopping. That average is a live number and it moves with rates, so pull it yourself rather than carrying one in your head — the point isn't the level, it's whether a given fund sits above or below the pack it belongs to. Compare like to like, too: a high-yield corporate fund will out-yield a short Treasury fund every day of the week, and that comparison tells you nothing except that they hold different things. As with dividend stocks: a yield that stands out is a question, not a find. Something inside is taking more risk, and the prospectus will tell you what.

Then fees, measured against the yield. An expense ratio in the abstract means little. Measured against what the fund pays you, it means a lot. One investor's rule of thumb — a sample, not a standard — is to keep a fund's expense ratio at or under about a tenth of its yield. Illustratively: a fund yielding 5% would cap you near 0.5%, while the same 0.5% fee against a 2% yield is eating a quarter of your income. Those numbers are made up to show the arithmetic. The arbitrary part is the one-tenth. The part that isn't arbitrary: you came here for income, and the fee is a permanent subtraction from the income you came for.

Then volume, for ETFs only. An exchange-traded fund (ETF) trades all day, which means you pay the bid-ask spread — the gap between what buyers are offering and what sellers will accept. Thinly traded ETFs have wide spreads, and you pay that gap going in and again coming out. Setting a minimum daily trading volume is how you filter for the ones that don't. A mutual fund prices once a day after the close, so this doesn't apply to one.

Sample entry rules, exit rules, and routines

Video coming soon

This lesson explains the idea in full without it.

Everything below is one investor's plan. Not a standard, not a recommendation, and not what we think you should do. It's written out so you can see what a finished set of rules looks like and argue with it. A plan you copied is a plan you'll abandon the first time it costs you something.

Entry: nearly nothing

The entry rule is anticlimactic, and that's not a shortcut. Buy bonds or bond funds that meet your criteria, in the amounts your allocation calls for, when you have cash. No waiting for a better price.

That sounds lazy next to everything you just read. It isn't. You didn't buy this for the price move — you bought it for the income and the return of principal, and neither depends on what you paid relative to last month. Market timing is trying to buy the bottom and sell the top, and reliably doing it is very rare. It's also beside the point here. A bond bought at a slightly worse price is a bond with a slightly lower yield to maturity that pays you on schedule anyway.

Exit: a genuinely different question

Now the part worth slowing down for, because if you carry stock habits into this you'll do real damage.

An individual bond you hold to maturity has an exit already. It's a date. You don't decide it. You didn't choose it as a target and you can't be talked out of it. On that date the issuer sends your par value back, and the position closes itself. That's not a strategy — it's the instrument.

Which reframes "when do I sell?" completely. For a stock, selling is how the story ends and you're the one who ends it. For a bond, selling early is abandoning the ending you were promised. You'd take whatever the market pays that day, which may be less than par, and you'd give up the one feature that made a bond a bond.

So the sample exit rule for individual bonds is short: hold to maturity. And the reasons to break it aren't price reasons:

• The issuer's credit deteriorated. Not the price fell — the borrower's ability to pay you back genuinely got worse. A downgrade, a business in trouble, a city in fiscal distress. This is the real one, and it's the reason ratings are worth watching after you buy and not just before.
• You need the money. A legitimate reason and an honest one. It means the ladder was built on the wrong assumption about your life, which is worth fixing, but selling to meet a real need isn't a mistake.

Notice what isn't on the list. The price dropped. Rates rose, so your bond is worth less than you paid. This is the trap, and it catches people who've done everything else right: a bond's price falling while you hold it to maturity costs you nothing. It's a paper loss. You get par back on the date regardless. Sell into that drop and you've converted a number on a screen into money that's actually gone — and you've done it for a reason that only makes sense for an asset that doesn't have a maturity date.

Even rebalancing bends to this. When your bond allocation drifts overweight, the reflex is to sell some down to target. This sample plan doesn't — it lets the overweight bonds mature instead, and redirects the returning principal elsewhere. Slower, yes. But it restores the target without selling anything before its date.

Bond funds have none of this. No maturity date means no ending to protect and nothing to hold to. So the sample exit rule for funds is the ordinary one: sell overweight fund positions during rebalancing to get back to target. Otherwise leave them alone.

Routine: where the plan is actually enforced

A routine is the scheduled work that keeps the rules from quietly becoming suggestions. For a bond allocation it's built around one recurring event: money comes back. Coupons arrive. Bonds mature and return par. Every time that happens, you have cash and a decision, and the decision is where the plan either holds or drifts.

One more thing about changing course. If you decide you want a different shape — shorter maturities than you have, or higher credit quality — change it slowly. Don't sell the ladder and rebuild it. Steer it: send each arriving coupon and each maturing principal toward what you want, and let the old rungs run out their dates. It might take several rebalancing cycles to get there. That's the price of not selling anything early, and it's cheap.

Figure

Where this leaves the bond unit

That's the whole loop for bonds. What a bond is, what moves its price, what the risks are, how a ladder works, how to read a quote, how to choose the bond or the fund, and what makes you sell. It's a complete plan for the bond slice of an income portfolio, and the shape should feel familiar — it's the same shape you built for dividend stocks, with the mechanics swapped out underneath.

Next comes real estate, and then cash. Different assets, same work.

Key takeaways

• On an individual bond, read the issuer, the credit rating, the maturity, the coupon, the price against par, and above all the yield to maturity — the coupon says what the bond pays, the yield to maturity says what you make.
• A callable bond can be taken back by the issuer when rates have fallen, which is exactly when you'd most want to keep it. The extra yield is what you're paid for handing over that option.
• A bond fund has no maturity date, so it has no yield to maturity and no promise of par. What it has instead is an expense ratio charged every year, an average duration, and a credit mix you have to read the prospectus to see.
• An individual bond's exit is a date, not a decision. You'd sell early because the issuer's credit deteriorated or because you need the money — never because the price dropped. Holding to maturity makes a price drop a paper loss; selling makes it real.
• Every number in a sample plan is one investor's choice. The routine is what makes any plan real: money comes back, and each time it does you either follow your rules or quietly stop having any.