What is Fixed Income Investing?
What is Fixed Income Investing?
23 March 2023
One of the golden rules of investing is to know where you invest. When you save money in Blossom, you invest in the Blossom Fund, which provides Australians with access to fixed income investments. The Blossom fund invests in a diversified portfolio of fixed income assets that aims to provide a return and protect your capital (aka your hard-earned savings).
This article will explore the concept of fixed income investing, and support you to become a more savvy investor.
But before we start, please note that this guide contains general information only and does not take into account your personal circumstances, financial situation or needs. Before making a financial decision, you should read the read the relevant Product Disclosure Statement and Target Market Determination of the specific financial product and consider whether the product is right for you and whether you should obtain advice from a financial adviser. Your investment in the Blossom Fund is subject to investment risk including the loss of capital invested and investment returns.
What is fixed income investing?
Fixed income broadly refers to an investment in something that pays a fixed interest or dividend payment during the term of that investment. When the investment matures, the original investment amount (a.k.a principal amount) is repaid to the investor.
What makes fixed income investment attractive is that the payments from fixed income securities are known in advance and remain fixed throughout the duration of the investment term. This can provide investors with more stability (for risks see below). Investing in Australian bonds and Global bonds differs from other investments such as Australian Equities and Global Shares where income can be minimal, variable or unknown in advance. Or hybrid securities which offer a blend of capital growth and income.
Investors can purchase fixed income securities directly, or choose to invest in fixed income exchange-traded funds (ETFs), separately managed accounts or managed funds. When investing in a fund, the Fixed Income Managers professionally selects investments to create an actively managed portfolio of securities on an investor's behalf.
Understanding fixed income investing
Fixed income investing means that you invest your cash funds for a longer and usually fixed-term. To compensate you receive income in the form of “coupon payments”.
There are many types of fixed income investments, which we explain in more detail below, and a range of benefits and risks that you should be aware of.
When selecting fixed income investments, it can be useful to refer to credit analysts and research ratings which can provide an independent opinion on the credit ratings and credit risk of these investments. By assessing the price and performance, price and yield, credit worthiness of a fixed income investment you can evaluate the “risk” of investing in that particular investment such as credit risk, default risk and liquidity risk.
Credit rating agencies typically assign letter grades to indicate ratings. S&P Global, for instance, has a credit rating scale ranging from AAA (excellent) to D (poor).
What are some examples of fixed income investments?
When investing for income, one common option is to invest in fixed income investments which offer more certainty over the level of return (and income) you may receive on your investment. Examples of fixed income investments include term deposits, government bonds, corporate bonds and debentures(a debenture is typically issued by a bank or company as a loan agreement which gives them security over the borrower’s assets.)
You can choose to invest locally in Australian fixed income securities, or global investors can also invest in international fixed income which includes bonds issued by foreign governments and companies.
For most fixed income investments, the interest or dividend rate and timeframe for investment are set from the outset– thus making them ‘fixed’ as the name suggests.
Some of the most common fixed income investments include:
Government bonds involve lending an amount of money to the government for a specified timeframe and the issuing government will commit to pay you an interest amount, most commonly referred toas the coupon rate.
If you hold this investment to maturity(the specified timeframe) you will receive your capital and your coupon(interest) on the investment. Depending on the bond, you may also receive coupon payments during the year as well as on maturity, i.e. the total return. So if you invested $1,000 in a government bond for 12 months with a coupon rate of 5% pa, you will receive $1,050 at maturity ($1,000 + $50 interest).
You can choose to invest in Government Bonds as an individual investor, or via a professionally managed fund or Government Bond ETF or a blended portfolio offering multi-asset solutions.
The federal government offers fixed income securities to consumers and investors to fund its operations, including Treasury bonds, Treasury notes, and Treasury bills. Treasuries are debt instruments in which investors are lending the U.S. government the purchase amount of the bond. In return, investors are paid interest or a rate of return. When the bond matures (or maturity date), investors are paid the face value of the bond.
Treasury bonds, notes, and bills have different maturity dates and can pay interest in different ways. However, all Treasuries have zero default risk, meaning they are guaranteed by the full faith and credit of the United States government.
T-bonds mature in 20 or 30 years and offer the highest interest payments bi-annually. T-notes mature anywhere between two and 10 years, with bi-annual interest payments, but lower yields. T-bills have the shortest maturity terms—from four weeks to one year.
A municipal bond is similar to a Treasury since it is government-issued, except it is issued and backed by a state, municipality, or county, instead of the federal government, and is used to raise capital to finance local expenditures. Municipal bonds can have tax-free benefits to investors as well.
Corporate bonds are very similar to government bonds however you would be lending to a public or private company rather than the government.
The risk of investing in corporate bonds is usually considered greater than investing in government bonds as the company guaranteeing the capital and interest, may, for example, go out of business.
Government bonds have the security of being backed by the Federal Reserve or the Reserve Bank of Australia etc. If you are investing in corporate bonds, it is important to research the company to ensure they have the capacity to repay your capital and the interest due to you.
Investors can typically expect to receive a slightly higher coupon or interest rate for a corporate bond than a government bond as the investment risk is higher.
Access to corporate bonds can be individual bonds, or through corporate bond ETFs.
Mortgage backed securities
Mortgage-backed securities (MBS) are fixed income investment products that are similar to bonds. They are debt securities that consist of a bundle of home loans and other real estate debt bought from the banks that issued them. Investors in mortgage-backed securities receive periodic payments similar to bond coupon payments. An investor who buys a mortgage-backed security is essentially lending money to home buyers.
Term deposits and CDs
Term Deposits (in Australia) and Certificate of Deposit (CD) (referred to in the United States)are a fixed income investments offered by financial institutions with maturities of less than five years. The rate of return is higher than a typical saving account, and they typically carry Government Backed capital protection up to certain limits.
What are the pros and cons of fixed income investing?
What are the advantages of fixed income investments?
Depending on your financial goals, fixed income investments can offer many potential benefits, including:
- Diversification - Fixed income broadly carries lower risk than Australian Shares and Global shares. Investing in fixed income assets is a good way to spread the “risk” of your portfolio as bonds are generally less sensitive to macroeconomic risks, such as economic downturns and geopolitical events
- Capital Preservation - means protecting the value of your investment .. Because fixed income typically carries less risk, these assets can be a good choice for more conservative investors, or for retirees and pre-retirees who have less time to recoup losses, or who are looking for reliable income solutions and income streams. Investors should be mindful of inflation risk (discussed below), which can cause your investments to lose value over time.
- Regular Income - Fixed income investments can help you generate a steady source of income by providing a fixed rate of return on regular intervals in the form of coupon payments on their bond holdings. This differs from floating rate bonds where the bond pays an interest rate that fluctuates with market prices. Municipal bonds, have the added advantage of providing an income that is exempt from taxes.
What are the risks associated with fixed income investing?
Whilst fixed income investments are considered defensive assets, there are still some risk associated with fixed income investing include:
- Interest rate risk -When interest rates rise, the bonds price falls, meaning the bonds you hold lose value. Interest rate movements are the major cause of price volatility in bond markets.
- Inflation risk - rising inflation can be a risk because bonds provide a fixed amount of income at regular intervals. If the rate of inflation outpaces this fixed amount of income, the purchasing power of their capital reduces.
- Credit risk - If you invest in corporate bonds, you may be exposed to credit risk (also known as business risk or financial risk). It is the possibility that a bond issuer could default on its debt obligation. If this happens, the investor may not receive the full value of their principal investment.
- Liquidity risk - Liquidity risk is the chance that an investor might want to sell a fixed income asset, but they’re unable to find a buyer.
These risks can be managed by diversifying investments within your fixed income portfolio and considering your other assets and investments.
Fixed income as an asset class is generally less volatile than equity (stocks) and growth asset classes, and is considered to be more conservative. A well-diversified portfolio should have some allocation to fixed income, which is likely to increase as the investor’s time horizon shortens (e.g. as retirement approaches).
We recommend seeking financial advice, reading the Financial Services Guide and Product Disclosure Statement (PDS) or working with a financial professional, investment manager or financial adviser to help you select the right investment option and fixed income solution for you. There are many ways to invest in fixed income investments, and getting the right solution for you may involve a range of investment vehicles, a specific investment portfolio or a blend of investment strategies.