What are the pros and cons of fixed-income securities?
Fixed-income securities usually have low price volatility risk. Some fixed-income securities are guaranteed by the government providing a safer return for investors. Cons: Fixed-income securities have credit risk, so the issuer could possibly default on making the interest payments or paying back the principal.
Fixed-income securities typically provide lower returns than stocks and other types of investments, making it difficult to grow wealth over time. Additionally, fixed-income investments are subject to interest rate risk.
Pros | Cons |
---|---|
Provide investors with stable, predictable returns | Typically generate lower potential returns than stocks |
Experience much less volatility than stocks | Come with interest-rate risk, as bond prices fall when market interest rates rise |
These are the benefits of investing in fixed-income securities: Consistent returns: Returns from fixed income securities are pre-determined. Thus, they offer consistent returns. Moreover, the risk of return fluctuations is minimal due to the lower variance than other instruments.
In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.)
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.
One of the biggest benefits of fixed-income investing is that it's considered low-risk. That's not to say there is zero risk associated with investing in fixed-income assets, but these investments are typically less volatile and provide a predictable rate of return.
What causes bond prices to fall? Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
Fixed-income securities are debt instruments issued by a government, corporation or other entity to finance and expand their operations. They provide investors a return in the form of fixed periodic payments and the eventual return of principal at maturity.
Fixed-income securities and equities are popular investments with millions of investors in the United States. Fixed-income investments pay regular interest and tend to have less risk, making them favorable to risk-averse investors. Equities, on the other hand, can have high returns, but also tend to be riskier.
Should I invest in fixed-income now?
Short-term bond yields are high currently, but with the Federal Reserve poised to cut interest rates investors may want to consider longer-term bonds or bond funds. High-quality bond investments remain attractive.
Investments that can be appropriate include bank CDs or short-term bond funds. If your investing timeline is longer, and you're willing to take more risk in order to potentially earn higher yields, you might consider longer-term Treasury bonds or investment-grade corporate or municipal bonds.
In current market circ*mstances, with higher bond yields, fixed income investments have become an attractive asset class again from a risk-return perspective. Apart from the attractive yield, bonds also offer resilience for adverse market developments in risk assets like equities.
Interest rates tend to begin to decline three months ahead of recessions and reach a cycle low about five months into recessions. During economic downturns, fixed income has been shown to provide diversification benefits and reduce the volatility of portfolios that include risk assets such as equities.
Even if the stock market crashes, you aren't likely to see your bond investments take large hits. However, businesses that have been hard hit by the crash may have a difficult time repaying their bonds.
Bonds – also known as fixed income – are essentially an IOU. Governments and companies borrow money when they issue bonds, then promise to repay it at the end of the bond's life.
Reducing your cost of living can be one of the most strategic money moves when you're on a fixed income. This might look like staying in your area but moving to a home with a lower cost to maintain, like trading in the big house with high utility bills or property taxes for a more affordable, lower-maintenance home.
Treasury Inflation-Protected Securities, or TIPS, are fixed-income securities that provide inflation protection. TIPS premiums increase when the Consumer Price Index rises and decrease when the CPI falls. It's important to understand the risks and consult with a financial professional before investing in TIPS bonds.
Building a fixed income portfolio may include investing in bonds, bond mutual funds, and certificates of deposit (CDs). One such strategy using fixed income products is called the laddering strategy. A laddering strategy offers steady interest income through the investment in a series of short-term bonds.
The yield of a bond is also based on the price paid for the bond, its coupon and its term-to-maturity. Rising interest rates affect bond prices because they often raise yields. In turn, rising yields can trigger a short-term drop in the value of your existing bonds.
Should I buy bonds when interest rates are high?
The answer is both yes and no, depending on why you're investing. Investing in bonds when interest rates have peaked can yield higher returns. However, rising interest rates reward bond investors who reinvest their principal over time. It's hard to time the bond market.
After bonds are initially issued, their worth will fluctuate like a stock's would. If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change.
The largest investors in bonds include central banks; institutional investors, such as pension funds, hedge funds, charitable foundations and endowments, insurance companies, mutual funds and ETFs, and banks; and retail investors, typically by means of indirect investments.
Equity markets offer higher expected returns than fixed-income markets, but they also carry higher risk. Equity market investors are typically more interested in capital appreciation and pursue more aggressive strategies than fixed-income market investors.
For investors, equity investments offer relatively higher returns than fixed income instruments. However, higher returns are accompanied by higher risks, which are made up of systematic risks and unsystematic risks.