Fixed income implies an investment wherein the payments are made on a fixed schedule and of a fixed amount, either by the issuer or the borrower.
However, it can also be used in another sense. This term can also be applied to an income that is derived from pensions or preferred stocks which are all fixed income sources. They do not vary.
What is Fixed Income Investment?
Fixed-income investment offers a determined or fixed rate of return. Here, the interest is generated over a defined period. Since it offers fixed returns on investments, they are considered better than derivatives and equities.
What are the Benefits of Fixed Income?
Below mentioned are some of the benefits linked to fixed income.
1. Lower Risk: Since they offer a fixed amount of return on investments, they are less prone to risks as compared with stocks. A major reason that works behind this is that fixed-income assets do not generally get much affected by macro-level variations.
In case, you hold a major amount of stocks in your portfolio, you can allocate some of it to fixed-income investments. By allocating a part of your portfolio to fixed-income investments, you can escape huge losses such as major fluctuations in stocks.
2. Capital Preservation: Capital preservation refers to safeguarding your investment’s absolute worth through assets that have a defined return of principal goal. It is highly recommended for investors who are near to getting retired to go for fixed income investments as it carries less risk. Because they do not have much time to cope with the losses, this can serve as a source of income for them.
3. Income Generation: Since they offer a fixed return on investments, they can provide you with a consistent source of income.
4. Total Returns: Some fixed-income securities have the potential to produce high returns. Taking on additional credit risk or interest rate risk can help investors earn bigger returns.
What are the Risks Associated with Fixed Income?
Below mentioned are the 4 major risks linked to fixed income.
1. Interest Rate: The bond prices will fall in case the interest rate rises. This will lead to a fall in the value of your bonds.
2. Inflation: Though fixed income investing offers a fixed rate of return; a problem can arise if the pace of the inflation rate outpasses fixed income.
3. Credit Risk: When you buy corporate bonds, you’re taking on credit risk as well as interest rate risk. The danger of an issuer defaulting on its debt obligations is referred to as credit risk. This way, the investor might fail to receive the principal investment’s full value.
4. Liquidity Risk: An investor is said to be suffering liquidity risk if they want to sell a fixed income asset, but they cannot find someone who would like to buy.
Types of Fixed Income
This type of fixed income offers low-rate returns. This is because you are required to invest money only for a few months. Low returns are also a reason why many of the investors shifted from short-term to longer-term investments.
It is used to cope with the cash flow required to main day-to-day operations.
This investment is also known as a bond. It implies an arrangement of debt between two parties- the issuer and the investor. The interest rate is largely dependent on treasury rates, and credit and duration risk that come up with the issue.
Below mentioned are the types of bonds.
3. Fixed Income Derivatives
Many financial derivatives have their value based on fixed-income products. These are used by big investors and companies to escape losses.
Third-Party Fixed Income Payment Streams
Some fixed income streams do not depend on the amount of investment. A third party guarantees the payment here.
How to Invest in Fixed Income?
As an individual, you can invest in fixed income via mutual funds and exchange-traded funds.
An individual investor can also possibly buy a single bond or any other fixed-income security. This way, you’re required to have a significant amount of assets to get a diversified portfolio of individual bonds built.
However, there are some hurdles that individual investors often face while investing in fixed income. These include- high minimum investment requirements, high transaction costs, and less liquidity in the bond market.
Its Impact on the Economy
The impact of fixed income on the economy can be described as-
Bond markets are used by companies to raise capital to expand their business and to grow. They receive the cash they need for day-to-day operations by using money market instruments.
Money market instruments refer to securities that offer large capital at a low cost to businesses, banks, and the government for a short period.
For other interest rates, they go for treasury bills, notes, and bonds. Treasury bills and the output are inversely proportional. When the demand for treasury bills falls, the output tends to rise. Then, higher interest rates are demanded by the investors on other fixed-income products.