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A total bond fund is a mutual fund that is made up of a mix of bonds designed to reflect a broad bond market. This type of fund will include bonds of short, medium and long maturities, from both public and private issuers. A total bond fund can also be an exchange-traded fund, or ETF. Because bonds are less liquid than stocks, sometimes bonds from multiple issues will need to be purchased in order to mimic the characteristics of a single bond that is unavailable for purchase.
The Lehman Aggregate Bond Index is the benchmark for total bond funds. This index is made up of government securities, mortgage-backed securities, asset-backed securities, and mortgage-backed securities. All of the bonds in the index have maturities greater than one year. Investors cannot purchase the index itself, but there are exchange-traded funds that track the index.
Total bond funds utilize an asset allocation strategy to diversify their portfolios in accordance with their goals. A total bond fund can also play an important role in the asset allocation of an individual portfolio. While no investment provides a risk-free rate of return, a total bond portfolio attempts to replicate the rate of return and risk tolerance of the index. Because the bond fund holds different types of securities, it generally will have a higher risk than a government security, but it should provide a better return as well.
Another type of bond fund is a municipal bond fund, which invests in municipal bonds. Municipal bonds are issued by states, counties, or some other entity such as a school district, in order to raise money for projects. A state may issue municipal bonds for a new bridge or a school district may have a bond issue to fund the construction of a new school or renovations to an existing school. Municipal bond funds are popular as a relatively safe investment with favorable tax implications, as the interest paid on them is exempt from federal tax, and usually from state tax if the purchaser is a resident of the state.
A complementary investment to the total bond fund is the total stock fund. A total stock fund owns all of the stocks of a certain type. It may be a large-cap total stock fund, which holds the stock of all companies with market capitalizations over $10 billion U.S. Dollars (USD), or the total stock fund of a given exchange or country.