Definition of Guaranteed Income Investment
Investors explore financial markets as a means to build wealth, while managing financial risks. Guaranteed income investments appeal to conservative savers that wish to avoid volatility within their respective investment portfolios. Guaranteed income investments are associated with credit securities, where borrowers pay out fixed interest payments before returning the loan principal to investors. Although the payments are guaranteed, fixed income investments introduce distinct risks.
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Identification
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Few investments can be described as guaranteed, because of shifts within the global and economic landscape. In America, U.S. Treasuries alongside bank certificates of deposit are identified as guaranteed income investments. Treasury securities are actually loans made out to the federal government, with maturities that range between a few days and 30 years. Treasury bills, notes and bonds are risk-free securities because of government authority to levy taxes and create money with the printing press.
Meanwhile, certificates of deposit are guaranteed investments because of FDIC guarantees. As of 2010, the FDIC backs up to $250,000 worth of deposits for each customer at each bank. Therefore, wealthy investors may increase their overall FDIC coverage by dividing their savings among several different banks.
Features
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Overall, guaranteed income investments pay out low returns because of the risk versus reward relationship. The risk/reward trade-off indicates that investors expect higher rates of return in exchange for taking on more risks. As of June 2010, Treasury securities maturing in two years are paying a minimum of 7/10 of 1 percent in annual interest rates.
The Federal Reserve Board influences interest rates for guaranteed income through its monetary policy. The Fed effectively lowers interest rates amidst recession to encourage institutions to borrow money, purchase equipment and make investments. Conversely, the Fed raises interest rates to slow down the economy when inflation is a concern.
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Considerations
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Interest rates for a particular class of guaranteed income investment generally increase with longer maturities. For example, 30-year Treasury bonds may pay 4 percent interest rates, while three-year Treasury notes make 1 percent payouts. Higher interest rates for longer durations compensate investors for the risks that arise from making financial commitments over greater periods of time.
Risks
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Guaranteed income investments are susceptible to inflationary, interest rate and opportunity cost risks. Inflationary and interest-rate risks are somewhat linked. Inflation refers to lost purchasing power associated with rising price levels in the long term. Again, the Federal Reserve often raises interest rates in response to inflation. Higher interest rates cause existing guaranteed income investments to lose value. At that point, newly issued securities pay higher rates than those that are already in circulation.
Opportunity cost risks describe missed profits from forgoing competing investments. Guaranteed income investors are unable to fully participate within economic growth and bull markets that enrich stock market investors.
Strategy
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Guaranteed income investments are effective for savers who are building toward intermediate-term goals, such as home down payments and college tuition expenses that are due over the upcoming 12 months. Guaranteed income securities allow for safety of principal, while providing some level of interest income.
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References
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