Bonds or bond funds in a RRIF

Is it better to buy individual bonds or a bond fund for someone living exclusively on their RRIF? My gut feeling is that individual bonds are better, largely because the returns are predictable, plus if you hold the bonds to maturity there is no risk of suffering a capital loss.

For example, let’s assume you purchase $100,000 worth of 10-year bonds with a coupon rate of 6%. This means you would receive $6,000 of income for each of ten years, and then get your $100,000 principal back at the end of the period. If, on the other hand, you purchased $100,000 worth of units in a bond mutual fund, you may or may not receive $6,000 in income each year (of course you might in fact receive more but, then again, perhaps less), plus when it’s time to “cash in” your mutual fund units at the end of ten years, they may be worth less than $100,000 (or, yes, they may be worth more).

Question: Because of the potential volatility of the bond market, it seems to me that the true low-risk investor would be far better served by purchasing individual bonds and holding them to maturity, rather than buying a bond mutual fund.

Is there anything in my reasoning which misses the mark/p>

Answer: Your reasoning is correct. If predictability is important, then buying individual bonds in the manner you describe will produce a more certain result than investing in a bond fund, no matter how good it is. However, you must be sure you can hold the ten-year bonds until maturity, otherwise you run a degree of interest-rate risk. For example, suppose after a couple of years you found you needed to make a large one-time withdrawal from your RRIF for whatever reason and needed to sell some of your bonds to do so. If interest rates had risen in the interim, you would take a loss on the sale.

One way to avoid this risk is to build your own bond ladder. Instead of investing the full $100,000 in ten-year bonds, stagger the maturities. Perhaps have one-fifth of the bonds mature every two years. If the principal is not required, you can then roll them over into new ten-year bonds at that time. This strategy ensures that every two years you will have $20,000 in capital available to you if needed.