What Is Fixed Income Investing?

Fixed income investing is a strategy that focuses on capital preservation and consistent income. This income may come in the form of interest payments or dividends.

Fixed income investments typically include: certificates of deposit (CDs), government and corporate bonds, money market funds and fixed-rate annuities. Bonds can be bought individually or through exchange traded funds and mutual funds.

These investments are among the safest. Therefore, their return is relatively low. However, many people – such as those in retirement – use a fixed income investment strategy as a way to preserve their capital over the long-term.

Assets, like bonds, have reliable payouts on a fixed schedule. So you can count on them to serve as an extra income source. 

What Are the Differences Between Fixed Income and Equity Investing?

Equity (stock) and fixed income investing each have their respective risk-and-return profiles. Many investors will often choose an optimal mix of both strategies in order to achieve the desired risk-and-return combination for their portfolios. The classic portfolio is a 60/40 portfolio, with 60% allocated to stocks and 40% to bonds.

Equity investing offers higher returns than fixed income investing and appeals to people looking to grow their portfolio. However, higher returns are accompanied by higher risks. Risk takes shape in two forms: systematic and idiosyncratic risk. 

Systematic risk refers to market volatility in various economic conditions. Systematic risk cannot be avoided through diversification.

Idiosyncratic risk refers to the risks that depend on the operations of an individual company. Idiosyncratic risk can be minimized through diversification of your portfolio.

Fixed-income investing typically has lower risks than equity investing and appeals to people looking to preserve their capital, while making income. Of course, like any investment, there are pros and cons to a fixed income strategy:

Pros to fixed income investing

  • Capital preservation is all about ensuring you don’t lose the money you invest (known as the principal). In other words, if you invest $10,000 into a bond, you will still have $10,000 when the bond matures, plus interest.
  • Fixed income investing provides a reliable additional source of income. With interest rates on these investments somewhat higher than the majority of standard savings accounts, you get more ‘bang for your buck.’
  • With fixed income investing, there are less worries about all the many factors that may affect a stock. Just sit back and enjoy the arranged schedule of fixed income coming in.

Cons to fixed income investing

  • Inflation Risk: if your bond pays 2% interest and the inflation rate is 3%, your money is losing purchasing power.
  • Interest rates may rise. Bond prices do move in the opposite direction of interest rates because of the effect the new rates have on old bonds. So, if you are forced to sell your bonds before maturity, you could end up losing money because bonds with lower yields than current market rates are less attractive to investors.
  • Default Risk. Individual bonds are always at risk of default, especially those from corporations. It can happen if the company faces financial problems and can’t repay its debts. That’s why bond funds, owning hundreds of different types of bonds, are a way to mitigate this risk.

Why Choose Fixed Income Investing

Fixed income investments are popular because they offer a certainty that investors don’t get with stocks. Investors know that they’ll receive regular interest payments at a set rate and over a set period of time while their capital is preserved.

By comparison, stock investors get no such guarantee of a pay-out but can make a higher rate of return which is why many investors saving for retirement create a 60/40 portfolio, consisting of 60% equities and 40% bonds. The strategy behind the 60/40 portfolio is to provide growth through equities while reducing volatility on the fixed income side.

How to Invest in Fixed Income

Individual investors can buy a single bond or other fixed income security. However, doing so does not offer diversification. Also, sometimes there are high minimum investment requirements, high transaction costs, and a lack of liquidity in the bond market make it tough to follow this path. Which is why it is recommended that fixed income investors use exchange traded funds (ETFs) and mutual funds. A simple search on Magnifi indicates numerous ways for investors to access fixed income funds with low fees.

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The information and data are as of the October 13, 2021 (publish date) unless otherwise noted and subject to change. This blog is sponsored by Magnifi.

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