Fixed income investment is often the first choice for many who want to invest conservatively. With a stable and predictable income, investors can just sit back and let their money earn passively. While safer than many other investments out there, fixed income investments are not immune to risks.
Here we will look at the following regarding fixed-income investments:
Fixed-income investment is where investors are paid a fixed interest until its maturity date. After maturity, investors receive the principal amount they invested. Fixed income investments are often debt instruments, where the borrowers issue them to finance their operations, and investors buy the instruments to receive a monthly fixed income. The interest amount does not rely on the profit or loss of the operation, unlike equities - where the income is variable and dependent on surplus/loss. Investors of fixed income instruments are often the first creditors in line to be paid when the borrowers face insolvency.
Fixed-income investment is not only for conservative investors but also for people who want to diversify their portfolios. Portfolio diversification between fixed income and equities balances the return with risks.
Some of the most common examples of fixed-income investments are:
Fixed income investing perfect for individuals who may not have a high-risk tolerance. With their stable and regular income stream, investors have more opportunities to diversify their portfolio to offset the more volatile investment, such as stocks.
Moreover, investors’ rights and funds are backed by the issuer and, often, the state. Bonds are popular because the risks are not as high as stocks or other equities, and investors enjoy a contractual assurance. And even if the bond market suffers from fluctuation, the investor is bound to receive the money-back under contractual obligation. In terms of corporate and junk bonds, bondholders will be the priority creditors in case of liquidation. In the case of government and municipal bonds, their money is protected by state regulations. In CDs, the account holder carries mandatory protection up to 100,000 EUR by the guarantee fund.
Fixed income mutual funds and ETFs have the same benefits as normal mutual funds and ETFs. Aside from providing fixed interests, they are both liquid, and the cost of investing is lower than securities.
Does that mean that fixed-income investing is risk-free? Not at all - the risks under fixed income varies from other investment, and they are more subtle and reliant on external factors.
Risks of fixed income investment depend on the instrument. The risks of bonds are different from CDs and mutual funds. The following analyses the different kinds of risks of fixed income investment:
There is no way to eliminate risk on fixed income investment completely. However, you can hedge against those risks. Optimal asset allocation and portfolio diversification are critical for hedging investment risks in general. For individual types of risk, it depends on the type of investment instrument because each instrument has its own volatility and risks, and some require specific preventive methods to minimise losses against returns:
Fixed income investing perform best when combined with other investment strategies that aim for higher returns. Fixed income investing is designed to mitigate the risks associated with high-risk equities, such as stocks, and to balance equities' volatility by providing a cushion to limit your losses.
Last update: 10/08/2021