For investors who want to take the lowest risk with almost guaranteed principal and interest, fixed income investment could be a good choice for you. Fixed income means you invest a fixed amount of money and, in return, receive your principal back plus a fixed interest payout after a certain amount of time. Some examples are bonds, treasury bills, and fixed deposits.
For example, a $100,000 investment in a government bond, paying 3% interest per annum for ten years, will get you $3,000 in interest payout every year for the next ten years. After ten years, you will get your $100,000 principal back.
Why Invest in Fixed Income Investment?
Fixed income investment is popular among investors for several reasons:
Lower Risk
Preserving the initial principal is the main benefit of investing in a fixed income investment product. Unlike investments in higher-risk instruments such as stocks, fixed income investments guarantee the initial principal. There is no volatility.
Generally, government bonds with solid credit ratings have lower risk than private corporate bonds. In Singapore: Singapore Savings Bonds (SSB) and Treasury Bills are among the lowest-risk fixed-income products you can access because they are issued and backed by the Singapore government with the highest AAA credit rating. A fixed deposit has SDIC insurance protection for up to $75,000, which is also one of the safest instruments.
That said, not all bonds are created equal. Some bonds issued by private entities may not be as safe as the one mentioned above. Please do your research on the entities that issue the bonds before investing.
Stable and Guaranteed Return
When you invest in a fixed income investment, you know in advance how much you will get in interest payout for the duration of your investment. This clarity greatly benefits investors who prefer the stability of their investment performance without volatility. For investors in retirement, having a stable and guaranteed return with no volatility can be the primary deciding factor in choosing this investment type.
Consistent Income Stream
Bond investors will get an interest payout at a regular interval, ex: every six months. You buy, forget, and enjoy the regular payout. Many investors in retirement have a form of fixed income investment for this reason.
Diversification
With the unique risk profile and return characteristics, you can use fixed income investment to diversify your overall portfolio. Suppose you have exposure to more volatile assets (such as stocks, precious metals, etc.). In that case, you can soften the volatility of your portfolio by adding fixed-income products.
What about the risk?
Fixed income investment looks too good to be true? As safe as they sound, there are also some potential risks that investors should be aware of:
Low Rate of Return
Due to their low-risk profile, fixed-income products typically provide a lower rate of return, exposing you to inflation risk. If inflation is higher than the return on your investment, your investment value will be eroded by inflation over the long term. You will still lose your purchasing power even with all the interest payouts.
Default Risk
Although the initial principal is supposed to be guaranteed, there is a small risk of the entities guaranteeing the payment defaulting (or going bankrupt). In this case, you may lose the principal and interest payouts. To minimize this risk, we should look only at the companies with the strongest fundamentals. To be even safer, you can also look for bonds issued by the government. Generally, an entity with a higher credit rating should provide lower risk. For example, which would you trust more, a bond from the US government or the mom-and-pop pizza shop around your corner?
Liquidity Risk
Once you invest your capital, you have committed to lock your money until maturity and, in return, receive the interest payouts. That means you lose the liquidity of your capital until you get it back again after maturity. Some instruments may allow early termination, and some are tradable in the market, but generally, they have lower liquidity.
Examples of Fixed Income Investment
Bonds
Companies and governments typically issue bonds to fund their operation. They have fixed maturity dates and fixed interest payouts. You will get your regular interest payout throughout the bond duration, and you will get your principal back at maturity.
Treasury Bills (T-Bills)
T-Bills are short-term government bonds issued and backed by the government. T-Bills are among the lowest-risk investments suitable for investors with a lower-risk profile. T-Bills are sold at a discount to their face value, meaning investors paid less than the face value when it was purchased. At maturity, investors will receive the full face value of the t-bill. The discount is the investors’ profit.
Fixed Deposits
A fixed deposit is issued by a bank. You lock your capital for a fixed duration and receive your initial principal plus the pre-agreed fixed interest at maturity. Investing in a fixed deposit issued by a federally regulated bank allows you to enjoy insurance in case of bank default. Please note that there is a limit to the amount insured. For example, in Singapore, the insurance is only up to $75,000, a relatively small amount.
Should I have Fixed Income Investment in My Portfolio?
With the pros and cons of the fixed income investment, the answer depends on your risk profile and investing objectives. Everyone has different risk tolerance and goals, so do your own research to see if this type of investment fits your criteria.
Most investors hold a combination of growth and fixed income in their portfolios. Younger investors can afford to take higher risks and have a longer-term investment horizon, thus favoring more growth in their portfolios. As they grow older, the fixed-income portion tends to rise. You can enjoy your retirement better with stability from the fixed income investment.
