The fixed-income market, more commonly referred to as the bond market, consists of bond securities issued by the federal government, corporate bonds, municipal bonds and mortgage debt instruments.
Investing in a bond is considered less risky than stock market investments. As such, they typically offer lower potential returns.
Why do investors buy fixed-income securities?
As people move into retirement, fixed-income instruments become more critical to preserve capital and provide a guaranteed income stream.
Fixed-income securities are commonly used to diversify an investor’s portfolio because they reduce the overall risk of asset allocation.
Financial experts recommend holding a certain percentage of your portfolio in fixed-income securities. This mostly depends on how many years you have until retirement.
Fixed-income securities are more stable than pure equity holdings. Investors tend to rely on this asset class more during times of economic downturn or when steady income is the objective of the investment account. 2008 recession analogy.
Advantages to Investing in Fixed-Income Securities
Just as the name suggests, the income from fixed income securities is stable and most of the time, pre-determined. There are no potentials for higher returns through capital appreciation or the opportunity to outpace inflation with this strategy. There are, however, some unique benefits that an investor can obtain through fixed securities.
1. Stability of Principal
The fixed-income securities provide the peace of mind that comes from a stable portfolio balance and capital preservation. By definition, fixed-income securities are required to repay the original amount of the investment, after the maturity period of the investment.
For fixed-income securities that are highly-rated, as is the case with U.S. government bonds, there is a minimal risk that the entity offering the fixed-income security will be unable to repay investors in full when the investment matures.
2. Generates a Steady Income Stream
Apart from the benefit of capital preservation, fixed-income securities provide investors with a steady stream of income. Bonds, and CDs all pay a regular dividend and interest payments to investors, creating a consistent cash inflow to investors. Fixed-interest and dividend rates are set when the security is issued, and these payments are guaranteed as long as the issuing entity does not default.
Federal government bonds are the least likely to default on interest and dividend payments, while corporate bonds with lower credit agency ratings bear more default risk for investors.
3. Higher Priority Claim to Assets
If a company gets into financial trouble and needs to declare bankruptcy, the fixed-income investors will be given higher priority over stockholders. Investors in bonds of a corporation have a higher priority over common and preferred stockholders of the same corporation should the company declare bankruptcy. Bondholders, then, are more likely to be repaid their principal investment when assets are distributed during a liquidation event.
Here are some examples of Fixed Income Investments
1. Savings Account: A saving account provides a safe place to store your cash and earn some interest. The saving account is easily accessible, and there are typically no fees or terms on most savings account. There may be some restrictions on the number of times you can withdraw money from your savings account in a month. The interest rate depends on countries and the economy. During this period, the savings account in America generate, on average, about 2.25% per annum in interest.
2. Money Market account: The money market account is similar to the savings account in many ways, but it pays a higher interest rate than the regular savings account. They also have limits on transactions, but you can have immediate access to your money. The current average interest on Money market account is around 2.5%.
3. Certificate of Deposit:A certificate of deposit or CD is a type of savings account that has a fixed interest rate and a fixed maturity date before you can withdraw your fund. A CD does not charge you any fee unless withdrawn before the maturity date. It’s a low risk and low-interest form of investment, typically the average interest paid on CD varies from 0.5% to 3%, depending on the country and the overall health of the economy. The maturity term on a CD can range from as low as 12-months to as high as the 5-year CD. (SO BE SURE YOU CAN LEAVE YOUR MONEY TILL THE END OF THE MATURITY DATE)
4. Bond:Bond provides an opportunity to earn a fixed income. Government and corporations typically issue bonds, and they are interest-bearing security that obligates the issuer to pay the bondholder an agreed sum of money, at a specific period, with the goal of repaying the principal amount at maturity.
It is as if you are loaning the issuer your cash in return for interest payment on the loan. The rate you get on your money depends on the financial health and reputation of the issuing organization. Organizations are given ratings from AAA being the strongest with good financial standing to junk rating C or D for organizations with poor financial standing. The companies that carry lower ratings pay higher than the ones with higher bond rating, but they also possess higher risks. The coupon rate ranges from as low as 2% to as high as 12% based on the financial health of the issuer.
5. Annuity: An annuity is not widely accepted as an investment vehicle because it is mostly sold by insurance companies. It pays out income and can be used as part of a retirement strategy. Annuities are a popular choice for investors who want to receive a steady income stream in retirement.
Here’s how an annuity works:
You make an investment in the annuity, and it then makes payments to you on a future date or series of dates. The income you receive from an annuity can be cashed out monthly, quarterly, annually, or even in a lump sum payment.
You can opt to receive payments for the rest of your life, or a set number of years. How much you receive depends on whether you choose for a guaranteed payout (fixed annuity) or a payout stream determined by the performance of your annuity’s underlying investments (variable annuity).
You now know what Fixed income investing is about. You know the advantages and the shortfall of fixed-income investments. You have learned about some examples of fixed-income investments. So depending on your situation and your financial goals. You can either use the fixed income strategies to build your portfolio or a combination of both fixed income and equity market investing.