Before diving into the truth about Fixed Income Investments, it’s probably a good idea to know exactly what fixed income is and where it comes from.
Truth be told, fixed income sounds a lot more promising than it really is.
What Are Fixed Income Investments
The best way to sum it up – bonds.
Bonds work like this – you lend money to whichever institution you decide on (below you can choose the different types) and at the end of the term they pay you back with interest.
It’s foolproof and secure.
Unless you buy Junk Bonds (high yield bonds), and that’s just plain risky no matter what. So we won’t be touching too much on that subject in this post.
Also, you can check out some Fixed Income ETF’s for a bit of variety. They’re listed below.
However, there are a few things that you should know before committing to ‘easy’ money.
5 Bonds To Consider
1. US Treasury Bonds or Bonds for different countries. These are by far the safest.
Chances of a country going bankrupt, ironically, is becoming a higher probability, but still it is pretty damn safe considering your other options.
The way I look at it, if a country is going bankrupt, so are its banks. So you will have the same security level as in investing in the bank but at least you’ll get a higher percentage in return.
The best ones to get in this category are TIPS (Treasury Inflated-Protected Securities). They have a smaller interest rate, however, the price is adjusted with inflation.
2. Municipal Bonds – This is when you invest in a municipality or department in a city or country.
Usually municipalities give out bonds when they are doing projects. For instance, they want to build a new bridge, repair a road, construct a new building. Something along the lines of bettering the place. Since they don’t have the cash up front a lot of the times, they release bonds with percentages.
This is also a really safe investment. Unless of course there is corruption involved and the money somehow gets lost. Not a high probability of this happening.
Adjustable rate government bonds are a good bet, this way you don’t have to worry about the bond decreasing when the interest rates go up.
3. Corporate Bonds – this is considered the most riskiest of the four, but still pretty safe overall.
Corporations, like everyone else, look for lenders. It could be for starting new divisions, launching new products, or whatever it is they need money for at the time. They don’t have to disclose that information. Due to the higher risk, a higher percentage is also offered.
Shorter Term bonds are less risky.
4. Mortgage Securities Market – to get in on the mortgage action, you can lend money to financial institutions and they pay back a better rate due to all the people they gave out mortgages to. This was a pretty safe bet before the crash, and now it is becoming safer and safer to invest with again.
5. High Yield Bonds – these are the highest paying bonds, otherwise known as Junk bonds. Their yield and dividend or payout is much higher than all the other type of bonds. Which means they are also the highest risk.
They work similarly to corporate bonds, but the companies can be anything from start ups, penny stock companies, or anything that has a lot less credibility. Basically, they can default on their payments – and there is nothing you can do about it cause you signed up for the risk.
Best way to play this category is through ETF’s.
Shocking Truths and More about Fixed Income Investments
Caveats of acquiring bonds:
1. You have to buy them in bulk, usually a minimum of $1000, corporate bonds are usually $5000 and up
2. Find out the time period for each bond you invest in
3. Find out the percentage for each bond and if it is favorable to your goals
4. To have a good bond portfolio where you invest in individual bonds you need to have around $10,000 to start
5. There are ways to get around investing only in individual bonds – buy bond funds or bond index ETF’s, you don’t need a lot of money and you can still earn an income
Industry Recommendations When it Comes to Fixed Income – Does NOT Mean You Have to Do It
If you read anywhere online about adding fixed income to your retirement portfolio you will see the same formula over and over again for how much to invest.
Take your current age and turn it into the percentage of your fixed incomes.
Example: I am 42 years old, that means, by industry standards 42% of my IRA should be bonds.
Now to get out of industry standards and be able to make up your own mind. Let’s dive deeper into if it is worth it.
Benefits of Fixed Income Bonds
Consistent Payment – depending on the bond you can get a quarterly, bi-yearly or yearly payout. Or if you want, all at once when the bond expires.
Preservation of your Cash – when the bond matures you get all your initial investment back plus the interest
Tax exemption – when taking out government bonds you can have it as a partial or full tax exemption depending on the type of bond you get
Cons and Risks of Investing in Bonds
Maturity dates – bonds can be bought anywhere from one year to thirty years. What that means, you are not allowed touch the money at all, except for the coupons.
Interest Rates – Bonds are totally subject to interest rate rises and falls. If the interest rates rise, the bond rates fall and makes it worth a lot less. This is where adjustable rate bonds can play a great role.
Paying out – Chances are you will be getting safe bonds. But there can be rare occasions that the issuer of the bond can’t pay out completely. Best case scenario, if there is a problem, would be they pay back what you lent them without the interest. Worst case scenario they can’t even pay back the initial lending amount.
Reinvestment – Beware that when the bond matures, it can be instantly reinvested, make sure you have full control of this situation.
Inflation rates – with longer term bonds when they expire, the money you investing including the interest can be less than what it is worth due to inflation.
Advice for Choosing the Best Bonds and Fixed Income Funds
Shorter Time Frame – With today’s market the last thing you want to do is get into long term commitments. Stick to yearly or at most five year maturity bonds. Or even better, ETF’s which don’t depend on maturity.
Beating the Inflation – A serious problem with longer term bonds are inflation rises. The way to go around this is to invest in TIPS (Treasury Inflated-Protected Securities).
Avoid Interest Rate Hikes – Another problem is with interest rates rising, bringing down bond rates. This can be solved with adjustable rate bonds.
Bonds vs. Bond Funds – Unless you are investing a ton of money per bond, it is much better to diversify in a bond index fund.
Bonus – Best Lists of Fixed Income ETF’s
Disclosure: I am not recommending any of these directly. But as a resource list.
Marina 'The Trader Chick' Villatoro