Fixed-income investments is a steady stream of income through dividends or interest payments. In the world of pandemic and uncertainty, fixed-income is generally considered a less risky asset since there’s some predictability about what an investor can earn. Fixed-income investments to generate current income or retirement income for an investor’s portfolio.
What Is Fixed Income?
Fixed income broadly refers to those types of investment security that pay investors fixed interest or dividend payments until its 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.
1. Fixed income is a class of assets and securities that pay out a steady level of cash flows to investors, typically in the form of fixed interest or dividends.
2. Investors are repaid the principal amount they had invested in addition to the interest they have received at the time of maturity.
3. Government and corporate bonds are the most common types of fixed-income products. Fixed-income investors are often paid before common stockholders in the event of company’s bankruptcy.
Advantages of Fixed Income Investment
- Steady income stream
2. More stable returns/income than stocks
3. Higher claim to the assets in bankruptcies
4. Some are Government and FDIC insured
Disadvantages of Fixed Income Investment
- Returns are stable but lower than other investments
2. Credit and default risk exposure
3. Susceptible to interest rate risk – If an investor bought $2000 bonds at a rate of 3% but the government raised the interest rate by 5% then the investor is now locked with 3% interest rate.
4. Sensitive to Inflationary risk – Inflation rate increases every year and the purchasing power decreases. For example: If a Bond is bought at a rate of 3% and the inflation rate 2% then the investor gains only 1% income stream in real terms.
Types of Fixed Income Products
- Treasury Bills – They are short term fixed income, they mature within 1 year and they do not pay any coupon returns. Investors buy the bill at a price less than its face value and investors earn that difference at the maturity.
- CD (Certificate of Deposit) – A fixed income investment offered by financial institutions or banks (CitiBank, Bank of of America and etc.) with maturities less than 5 years and a very common fixed income investment. Normally, higher interest rate compared to savings and checking accounts but depends on the time frame and government interest rate.
- Fixed Income ETFs – They are similar to mutual funds and the funds target specific ratings, interest rate, durations and other factors. They also carry a management expense.
- Treasury Notes – Commonly known as T-Notes, maturity comes in between 2 and 10 years, pay a fixed interest rate. It can be bought in a multiples of $100, and at the end of the maturity, investors are repaid the principal but earn semiannual interest payments until maturity.
- Treasury Bonds – They are commonly known as T-Bonds, similar to T-Notes and can be bought in multiples of $100 but they mature 20 – 30 years.
- Treasury Inflation Protected Securities (TIPS) – They protect investors from inflation, interest rate is adjusted according to inflation and deflation. Minimum duration of ownership has to be 45 days.
- Municipal Bonds – They are government issued so it is similar to Treasury but they are issued and backed by the state, local, municipality and county in order to finance the expenses and raise local capital. Investors also enjoy a tax free benefits.
- Corporate Bonds – They come in various types, prices and interest rate issued by large corporations depending on their financial stability and creditworthiness. Typically, bonds with higher credit ratings offer low coupon rate.
- Junk Bonds– Commonly known as High Yield Bonds and are corporate issued and pays a high coupon rate due to its high risk of default. Default is when a company fails to pay back the principal and interest on a bond or debt security.