Let’s take a look at the point of view of fixed income investing first. Broadly speaking, it refers to the types of investment securities that pay investors fixed interest or dividends until maturity. At maturity, investors are reimbursed for the capital they have invested. Unlike stocks, which may or may not provide cash to investors in variable income securities, and where payouts can change based on certain underlying metrics.
There are companies and governments that issue securities to raise funds to finance day-to-day operations and finance the large projects they undertake. For an investor, fixed income instruments can be a set of sums of interest in exchange for investors to lend them money. At maturity, investors are reimbursed for the initial amount they had invested, called the principal amount.
For example:
A company can issue 5% interest with a face value of 1000 rupees in 5 years. An investor who buys the bond for 1000 rupees and will only be repaid at the end of the five years. And for the five years, the company pays interest amounts called coupon payments based on the rate of 5% per annum. As a result, the investor is paid 50 rupees for 5. After 5 years, the investor is refunded the full 1000 rupees he had originally invested. The investor will also find fixed income investments that pay monthly, quarterly or semi-annual coupons.
Who should invest in fixed income securities?
These fixed income securities are recommended for conservative investors looking to diversify the portfolio. The percentage of the portfolio dedicated to fixed income securities depends on the investor’s investment method. There is also an opportunity to diversify the portfolio with the combination of fixed income and equity products that create a portfolio that can contain 50% fixed income and 50% equities.
As an investor investing in fixed income securities, what are the potential benefits to you?
Potential benefits
Diversified stock market today
Fixed income securities are generally defined as having less risk than stocks. This is because fixed income assets are generally less sensitive to economic risks such as economic downturns and geopolitical events. So if you are an investor looking to grow your wealth in investments over time or save for retirement, you probably have a significant amount of stocks in a portfolio. But allocating a portion of your portfolio to fixed income securities can potentially help establish losses when the stock markets swing.
Preservation of capital
It is about protecting the absolute value of your investment through assets that have a stated objective of return on capital. An investor who is already near retirement can rely on investments to generate income, as fixed income securities generally pay less and can be a good choice of assets for investors who have less time to recoup their losses. Apart from all this, you should always be aware of the risk of inflation, which can cause your investment to lose value over time.
Income generation
Fixed income funds can help you generate a stable source of income. As an investor, you would receive a fixed amount of income at regular intervals in the form of coupon payments on holding bonds. And in the case of silver, income from municipal bonds is exempt from taxes.
Total return
Some of the fixed income assets have the potential to generate attractive returns over time. An investor seeks a higher return by taking on more credit risk or interest rate risk, so that the end product becomes capital with interest earned.
Strategies for achieving your financial goals with fixed income investments
Maximize Your Portfolio Returns – When you hold fixed income investments for a period of time, you can weather market fluctuations.
Using the Barbell investment method
Use a dumbbell strategy; it involves investing on the short and long ends of the yield curve. When rates start to fall, the long end offers potential for capital gains.
The matched asset program
This is when you can match high risk investments like stocks, mutual funds, etc., with zero coupon Treasury bonds that guarantee a portion of the return on the initial investment.
Buy bond investments at a reduced price
Buying bonds with lower coupons than a reduced face value can offer various advantages.
Get top-quality bond investments
These are the bonds that are above their face value, but they offer higher yields than non-redeemable bonds.
Risk and reward ratio analysis
You need to make purchases based on the shape of the curve, for which you need to analyze the risk and reward between buying bonds with different maturities.
Associated risks
Every coin has two sides, just like a fixed income fund. There are certain risks associated with fixed income securities, and they are discussed below.
Interest rate risk
When interest rates rise, the price of bonds goes down, which means that the bond you hold falls in value. Fluctuations in interest rates are the main cause of price volatility in the bond market.
Inflation risk
Inflation is another major source of risk for all bond market investors. A bond provides a fixed amount of income at regular intervals, but if the rate of inflation exceeds this fixed amount of income, the investor would lose his purchasing power.
Credit risk
For example, if you are an investor in corporate bonds, you assume credit risk in addition to interest rate risk. Credit risk, also known as business risk, is the possibility that an issuer will default on its debt. If this happens, an investor may not receive the full value of the invested capital.
Liquidity risk
Liquidity risk is a possibility that investors want to sell fixed income as is, but are unable to find the potential buyer.
How is a fixed income fund different from a floating rate fund?
Floating fund
A floating rate fund is a fund that allows investors to invest in financial instruments that pay a variable or floating rate of interest or a variable interest rate fund that invests in bonds and debt securities whose payments fluctuate with an underlying interest rate. So the interest rate that an investor receives depends on the performance of the fund in the market, for example, you can consider the HDFC Floater Fund.
Fixed income funds
Fixed income funds are a class of assets and securities that pay out levels of cash flow to investors, typically in the form of fixed interest or dividends at maturity.
Ex: SBI Magnum Income Fund.
Although these two funds pay interest, one remains constant while the other varies depending on the performance of the market. In this case, an investor with a low appetite for risk might choose a fixed income fund rather than a floating rate fund.
Conclusion
Fixed income funds have a higher claim on bankrupt assets and on government. You can always manage the environmental risks associated with this fund with the appropriate strategies as they are very moderate. The investment market offers great deals alongside tiny risks. With a fixed income fund, it’s a great way to balance your portfolio by keeping your gains outweighing your losses.
Interesting related article: “What does risk aversion mean?” “