Fixed Income

Fixed Income Investments

Fixed income broadly refers to those types of investment security that pay investors fixed interest or dividend payments until their maturity date. At maturity, investors are repaid the principal amount they had invested. Government and corporate bonds are the most common types of fixed-income products.

 

Unlike equities that may pay out no cash flows to investors, or variable-income securities, where payments can change based on some underlying measure—such as short-term interest rates—the payments of a fixed-income security are known in advance and remain fixed throughout.

Understanding Fixed Income
Companies and governments issue debt securities to raise money to fund day-to-day operations and finance large projects. For investors, fixed-income instruments pay a set interest rate return in exchange for investors lending their money. At the maturity date, investors are repaid the original amount they had invested—known as the principal. Fixed-income securities are recommended for conservative investors seeking a diversified portfolio. The percentage of the portfolio dedicated to fixed income depends on the investor's investment style. There is also an opportunity to diversify the portfolio with a mix of fixed-income products and stocks creating a portfolio that might have 50% in fixed-income products and 50% in stocks.
Advantages of Fixed Income

Fixed-income investments offer investors a steady stream of income over the life of the bond or debt instrument while simultaneously offering the issuer much-needed access to capital or money. Steady income lets investors plan for spending, a reason these are popular products in retirement portfolios.

  • Relatively Less Volatile:  The interest payments from fixed-income products can also help investors stabilize the risk-return in their investment portfolio—known as the market risk. For investors holding stocks, prices can fluctuate resulting in large gains or losses. The steady and stable interest payments from fixed-income products can partly offset losses from the decline in stock prices. As a result, these safe investments help to diversify the risk of an investment portfolio.

  • Money market funds:      A type of mutual fund which specializes in short-term debt securities. Since they aim to have a stable asset value level, these funds are considered to carry little risk while providing regular dividends.
The risk associated with fixed-income investing

Although there are many benefits to fixed income products, as with all investments, there are several risks investors should be aware of before purchasing them:

  • Credit and Default Risk : The credit risk linked to a corporation can have varying effects on the valuations of the fixed-income instrument leading up to its maturity.
  • Interest rate risk: This risk happens in an environment where market interest rates are rising, and the rate paid by the bond falls behind.
  • Liquidity risk: This is the risk associated with long-term illiquid investments. For example, if you’ve bought bonds and you suddenly need liquid capital, there’s a risk that you may not find a buyer for your bonds on short notice.

Type of bonds
  • Government Bonds: A government bond is a debt security issued by a government to support government spending and obligations. Government bonds can pay periodic interest payments called coupon. Government Bonds issued by national governments are often considered low-risk investments since the issuing government backs them. Government bonds issued by a federal government may also be known as sovereign debt.
  • Corporate Bonds: A corporate bond is a type of debt security that is issued by a firm and sold to investors. The company gets the capital it needs and in return the investor is paid a pre-established number of interest payments at either a fixed or variable interest rate. When the bond expires, or "reaches maturity," the payments cease and the original investment is returned. The backing for the bond is generally the ability of the company to repay, which depends on its prospects for future revenues and profitability. In some cases, the company's physical assets may be used as collateral.
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