What Is Fixed Income Investing?
Fixed income investing is investing in fixed income instruments. Fixed income instruments are mostly debt obligations with interest payments fixed for the life of the instrument. Investors buy fixed income instruments for current income.
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Fixed Interest Instruments
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Fixed income instruments are bonds, preferred stocks, bank loans, mortgages, certificates of deposit and money market instruments, such as commercial paper or repurchase agreements. Bonds, preferred stocks and money market instruments are securities that can be traded in the secondary market. Bonds are issued by corporations and governments. Preferred stocks are issued by corporations. Preferred stocks are not debt obligations but represent ownership in an issuing corporation, but because of the high fixed dividends and other features they are considered and act more like fixed income instruments than common stocks. Mortgages are issued by banks and can be repackaged and sold as collateralized mortgage obligations. CDs are bank products and essentially are debt instruments where banks borrow money from depositors. Most money market instruments are short-term securities that can be issued by corporations and governments.
Fixed Income Products
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Fixed income products, such as bond mutual funds, closed-end funds and fixed annuities, are financial products based on fixed income and equity instruments to provide current income. Bond mutual funds are investment companies that issue shares to investors and use the proceeds to buy specific types of bonds, such as corporate or municipal bonds. Bond closed-end funds issue a limited number of shares that trade on an exchange like a stock and buy specific types of bonds or bank loans with the proceeds. Money market funds invest in money market instruments. Unlike that of individual bonds, bond fund interest income and principal are not fixed and can change from month to month, but bond funds are still considered the most popular vehicles for fixed income investing. Fixed annuities are created by insurance companies that can use bonds or real estate as underlying instruments to derive current income.
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Benefits
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The main benefit of fixed income investing is current income. Bonds pay interest semiannually, preferred stocks -- quarterly, bond funds -- monthly, and many money market instruments -- at maturity. Capital appreciation is secondary. The amount of income varies greatly with interest rates, the specific type of instrument, and its maturity and credit quality. The longer the maturity and the lower the credit quality, the higher the interest.
Risks
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The principal risk of fixed income investing is interest rates. When interest rates rise, fixed income instrument prices fall. Another major risk is inflation, or loss of purchasing power: a 20 year bond will pay the same amount of interest until maturity, but every year that income will buy the bondholder less because of rising prices. Other risks include the risk of loss of principal: an investor can lose his investment if the issuer defaults on its obligations and declares bankruptcy.
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