Why are Bonds Known as Fixed Income Investments?
Savvy investors love to diversify their portfolios across several asset classes to protect themselves against unforeseen turns in the investment market. One of the ways they do this is through ownership of bonds.
Bonds have developed a reputation for being less volatile than other investment sources; they deliver a steady income stream while shielding the investor’s principal even in a falling market. This characteristic is no surprise, as bonds are generally classified as fixed-income investments. But what does the term ‘fixed-income’ mean, and what are the benefits of owning fixed-income assets? Read along to find out.
What are Fixed Income Investments?
Fixed-income investments pay their investors fixed interest or dividend payments until maturity. They tend to focus more on capital preservation and a steady income stream. They are typically low-risk, low-reward investments whose principal goal is to deliver as much income as possible with as little risk to the investor and the amount invested. Fixed income has three significant characteristics:
- They are more focused on capital preservation.
- They have an unwavering stipulated (fixed) interest payment at specified intervals.
- The owners bear little to no risk of the business they invested in, nor do they own any part of the business.
Government and corporate bonds are prominent examples of fixed-income investments.
What are Fixed Income Bonds?
Bonds are debtor notes issued by either government or corporations to investors. Other investments usually pay out variable income securities based on underlying measures like short-term interest rates. Fixed-income bonds pay a fixed, predetermined rate that doesn’t change throughout the bond’s duration.
When many fixed-income bonds mature, the company pays the investors the equivalent of their principal and specified fixed interests. If the bond issuer defaults, the investor gets paid first before the stockholders.
Types of Fixed Income Bonds
Fixed-income bonds are an essential concept for both the issuer and the investor. The bond issuer gets to raise needed capital for projects or other operations without losing shares or control over its company. In contrast, the investor gets a regular fixed income with minimal risk of loss. Here are some common types of fixed-income bonds:
Government bonds are fixed-income bonds entirely issued and backed by the government of a country or region. They are also called municipal bonds at the state or local government levels. They are considered among the safest bonds to undertake amongst investors, while the government uses the funds to embark on annual expenditures. Most of them are tax-free.
Corporate bonds are issued and backed by private institutions; their value and risk assessment are based on their creditworthiness and the collateral to which the bond is tied. Corporations with higher credit ratings pay lower interest rates, and money obtained from bonds is helpful to a company’s expenditure.
Junk Bonds or High Yield Bonds
Because many bonds are low-risk investments, they usually come with lower returns. High-yield bonds come with higher returns but at a significantly higher risk. This increased risk results from being issued by corporations with low credit ratings or the assets tied to them being shaky. Investors who can manage more risks go for this bond type.
Certificate of Deposits
A certificate of deposit is a fixed deposit account with significantly higher profit rates, and financial institutions usually offer them a maturity of fewer than five years. Additionally, certificates of deposits come with National Credit Union Association (NCUA) protection.
Fixed Income Bonds to Buy in the United States
With a sound investment strategy, you can buy several fixed bonds in the United States. Here are some of the more prominent ones:
Treasury Bonds (T-Bonds)
Treasury bonds are issued at the Federal level and backed by the United States. They are considered one of the safest bonds and have 20 to 30 years of maturity. You can purchase them in multiples of $100.
Treasury Inflation-Protected Securities (TIPS)
One of the risks often associated with bonds is the depreciation of the principal’s value due to inflation. TIPS protect the investor from all that as the value adjusts with deflation and inflation.
Treasury Notes (T-Notes)
Treasury Notes are similar to treasury bonds but have a lower maturity length. While T-bonds mature in at least two decades, T-Notes have a much shorter time frame of two to ten years. Like T-bonds, however, they are acquired by an increment of $100.
Municipal and Private Corporate Bonds
Municipal bonds are issued at state and local government levels and can also be invested in the United States. In addition, several private corporations also offer bonds to investors when they wish to raise funds for a project or venture.
Fixed Income Investment Strategies
Although bonds are relatively safe for the investor, they still must be cautiously approached. Here are just a few strategies you might want to use:
Laddered Bond Portfolio Investment
The laddered investment strategy is focused on diversifying bond portfolios by acquiring bonds with different maturity dates. This strategy enables the investor to use the principal of lower rung bonds in higher rung bonds.
Bullet Bond Portfolio Investment
This investment strategy involves purchasing various bonds at different dates but with the exact maturity dates. The strategy works for investors who need massive amounts of cash at a future date.
Barbell Bond Portfolio Investment
The Barbell strategy requires investing in very short-term and long-term bonds. The investor has to pay attention to his investments to keep reinvesting the short-term bonds when they mature.
Benefits of Fixed Income Investments
Fixed-income investments are highly beneficial in many ways. Some of the advantages of this sort of investment include the following:
- They make it easier to diversify your investment, especially when the market is very volatile.
- They provide good returns and a steady stream of income.
- Fixed income comes with a relatively lower risk exposure than other investment classes.
- Fixed-income bonds are less likely to be affected by market volatility.
Bonds are known as fixed investments because they offer fixed interest returns and have significantly lower risk exposure than most investments. You can choose multiple bond investment types and strategies for these investment routes. Investing in fixed investment bonds is one way to save something for a rainy day. Contact REICG Real Estate Investment Fund.