Why are Bond Funds classified into different terms such as Medium Term and Long Term?

Bond funds are classified into different terms such as Medium Term and Long Term primarily to differentiate the degree of risks associated with the investments. Each term category reflects the average maturity of the bonds held within the fund, which influences the interest rate sensitivity and overall risk profile.

Long-term bond funds typically invest in bonds with maturities greater than ten years, and they are subject to higher interest rate risk; this means that if interest rates rise, the value of these bonds may decrease significantly. Medium-term bond funds, on the other hand, invest in bonds that are usually set to mature between four to ten years. These funds present a more balanced risk exposure compared to long-term funds, as they are less sensitive to interest rate changes.

By classifying bond funds based on their terms, investors can better align their investment choices with their risk tolerance and financial goals. This classification enables investors to identify the potential volatility and expected returns associated with the maturity periods of the bonds held within each fund. Understanding the risk differences allows investors to make more informed decisions based on their investment horizon and strategy.