Fixed Income Investing for Beginners
Fixed income investing is easy and safe, but is it worth it? Here’s a look at fixed income investing for beginners.
Are you a risk-averse investor? Here’s a hint: if you prioritize capital preservation above all else, you’re risk-averse.
And if you’re risk-averse, there’s a good chance you’ve heard of safe investments like fixed income investing before.
What is fixed income investing, and is it the right choice for you? Here’s a closer look at fixed income investing for beginners so that you can make the right choice for your portfolio.
What is Fixed Income?
Fixed income refers to types of investment securities that pay a fixed interest or dividends until the security reaches its maturity date. Once the security reaches its maturity date, investors receive back the principal that they originally invested in the security.
In plain English, this means that fixed income investing is a type of investing that offers investors a steady income stream over time and is less risky than stocks. Rather than the educated guesses that allow you to make money on the stock market, you can always count on the same income from a fixed income investment.
Types of Fixed Income Investments
There are several types of fixed income investments operating on the same basic principle. These include things like:
- Certificates of deposit
- Money market funds
- Fixed-rate annuities
- Treasury bills
- Treasury notes
- Fixed-income mutual funds
- Fixed-income exchange-traded funds (ETFs)
The most common type of fixed-income security is a government bond, a debt security issued to support government spending. You’re basically giving the government a loan for a fixed period of time with a set interest rate. For example, if you bought a $1,000 bond from your state government with a two-year term and 5% fixed annual interest, you would receive $50 in interest each year and $1,000 at the end of two years, for a total of $1,100.
How Fixed Income Investing Works
Fixed income investing works quite differently from securities you’ll encounter elsewhere on the market. This is why fixed income investing is among the safest options and why it’s popular among risk-averse investors.
Unlike other securities, fixed income investments are concerned with specific monetary goals. Because of those goals, they deliver pre-determined, reliable payouts on a fixed schedule so that you can rely on them as income.
This is quite different from the stock market, which doesn’t pay out until you sell the stock and offers no guarantee of returns—it’s all based on long-term strategy and making the right moves at the right moment.
The foremost benefit of fixed income investing is security.
When people turn to fixed income investments, they’re primarily concerned with a strategy called capital preservation, which promotes preserving capital and limiting loss of value by avoiding unnecessary risks. This isn’t a good long-term approach, but for short-term investments, it’s the safest and most successful way to invest.
At the bare minimum, you won’t lose any value in capital preservation. This is important if you’re looking at short-term investments within the next few years. This is especially common (and important) for retirees, since you’re at a point in your life where stable returns matter more than huge returns.
In addition, fixed income investing offers diversification from stock market risk. That way, you’ll have stable investments you can count on to hold value, even if your other investments fail.
Fixed income investments also provide a stable additional source of income, which is important for retirees who rely on their investments for income in place of the salary they relied on while they were working.
Unfortunately, risk and reward go hand-in-hand in investing. Fixed income investing is one of the least risky investments out there. On one hand, this means the investments generate reliable returns. On the other hand, the returns aren’t as good as some riskier options.
There’s also the risk of rising interest rates. If you buy a bond and interest rates rise in the intervening years, bond prices fall, which means that the bond you hold loses value.
Then there’s the risk of inflation. In economics, inflation is the decrease in purchasing power for a given currency over time. This typically happens when the average price level of a selected basket of goods increases over time, which means a unit of currency buys less than it did a few years ago. Unfortunately, since fixed income investments have low rates of return, they don’t keep pace with inflation, so your income declines in value over time.
Who Benefits from Fixed Income Investments? Who Doesn’t?
Generally, fixed income investments are only a good choice for those who need capital preservation above all else, which usually means retirees. Otherwise, the returns from fixed income investments just aren’t good enough to justify investing in them over a slightly riskier alternative if you know you have time to make up a loss.
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