Fixed Income Investments are traditionally focused on preservation of capital and steady income. A dominant form of fixed income investment is a bond.
The generally accepted concept for fixed income investments is that they offer a steady stream of income with less risk than stocks.
There are some challenges with fixed income investments. However, fixed income investments are an important part of any investment portfolio.
The Balanced Portfolio and Bond(s)
In a portfolio, these lower risk investments offset other higher risk investment types.
A balanced portfolio should always contain investment grade fixed income holdings to balance risk in the overall portfolio. This is called asset allocation.
In fact, a common asset allocation recommendation is holding 25% of your portfolio in fixed income investments. Furthermore, you can find advice and calculators on determining your asset allocation recommendation based on your age if desired.
While, currently returns are very low due to the ongoing decline in long-term central bank yields, or interest rates. Bonds face inflation risk, currency risk, and some carry default risk.
Bond(s) Are Not A Liquid Investment
Bonds to the individual are an investment. You put up your capital for a fixed period of time and earn interest. On the other hand, bonds are a debt to the entity (corporation) offering the bond.
When you lend your money, you must ensure you see an adequate return on your investment of capital.
As a matter of fact, I recommend you have a target return on investment determined. Possibly as part of an investment policy. In fact, this assists in guiding your decisions when selecting fixed income investments.
Your primary goal is protection against loss of capital, this includes loss against inflation.
Types of Bond(s) Include
- Government/Treasury Bonds – fund government spending activities – investment grade
- Corporate Bonds – fund corporate spending needs – may be investment grade
- Municipal Bonds – fund municipal government spending activities – speculative
- Foreign Bonds – issues in a domestic market by a foreign entity in the domestic markets currency and may fund foreign government and foreign corporate spending activities – speculative
- Junk Bonds – fund corporate spending needs – not investment grade – high default risk
Bonds can be safer than stocks. However, the lower returns make them less desirable when economies are strong.
The days of 5% and higher treasury and government bonds are gone, and it could be some time before we see those types of government backed yields again.
As a result, this has pushed more investors into other types of holdings to protect against loss of capital due to inflation. Not to mention, current government and treasure bonds do not cover inflation.
Bond(s) Compete With Stocks For Investment Dollars
One corporation may offer both bonds and stocks to investors and each come with their own advantages and disadvantages.
When dealing with corporate bonds the only way to know if a bond you purchase in Corporation A is safer and a better investment than a stock purchased in Corporation A is to carefully review the business and bond indenture.
A bond indenture is a legal document that outlines the parameters of the bond issue such as face value (Par), issuer, coupon rate, rights of bondholders, callability, etc.
Further, it is difficult to gain transparency on bonds and this can prevent an investor from properly assessing the grade of investment that is being offered.
Typically, when stock markets decline bond markets see an increase in demand. Actually, this balancing can be seen if you were to plot an index fund against government or treasury bond performance.
As stock markets decline bond markets see an influx of investments, as stock markets gain momentum bond markets decline.
Bond(s) Over The Counter
Bonds are sold over the counter in two separate markets. The primary bond market is typically where bond buyers purchase new issues directly from bond issuers. There is a high bar for entry into these transactions. This means minimum capital transactions are high. Possibly, leaving this source inaccessible to someone entering the investment market with low capital holdings.
The secondary bond market offers a variety of products based on the bonds already purchased in the primary market.
Secondary market offerings can be purchased from brokers. Additionally, capital requirements are typically lower for entering this market.
Examples of bond brokers include your bank, investment bank, online brokerage, etc.
Brokers make money from the fees charged on transactions and from commissions. Shop around for a broker and ask what commissions and fees you are paying.
Complexity In Secondary Bond Markets
Secondary market offerings can get complex. Let alone, in some cases these investments no longer hold the transparency or security of the initial pure bond offering.
Secondary Market investments that are based on primary market bonds include:
- Strip Bonds/Zero Coupon Bond – represent a debt instrument where the principal and regular payments of a bond have been removed and sold separately
- Bond Exchange Traded Funds (ETF) – holds bonds which trade on the exchange trying to replicate returns of the bond – these do not mature as a bond would – liquid investment
- Mutual Funds, Bond pools
In my view none of these offerings constitute a fixed income investment. As a matter of fact, some are likely derivatives.
In the above examples the central purpose and benefit for bond investment has been removed. The secondary market is selling these products and groupings of products as a fixed income investment.
I do not recommend these ventures. And, if you choose to make them part of your portfolio 1. research what you are putting your capital into; and, 2. stay as close as possible to the initial bond offering.
An Example
This is an example of performance of one of the products above. This holding is performing much like a volatile stock would. Initially, in our notes we identified the primary purpose of fixed income assets as a holding that offers a steady stream of income AND has less risk than stock.
This is not what we see in the performance of this example. Actually, the performance of this investment clearly shows no protection of capital and proves it is not a fixed income grade investment.
Give It To Me Straight
If you work with bonds you should be dealing with the straight bond. This involves you investing your capital for a product that pays you interest plus pays back your principal at maturity.
Anything else is not a secure fixed income investment.
Alternatives To Bonds
Fixed Income Alternatives to Bonds:
- Certificate of Deposit (CD) are offered by banks and pay a higher interest rate in exchange for leaving your capital deposited for a fixed period. Benefits to you include locked in rate, transparent terms, variety of terms available, safe, and sometimes insurance.
- High Interest Savings Accounts and Money Market Accounts.
How Much Can I Make?
How much money can I make on fixed income investments you ask?
Government and Treasury 10-year bonds are offering 0.59 to 0.67%.
Recent corporate 5 to 7-year bonds reviewed included $1000 face value bond offerings. Further, these are from corporations with AA credit ratings, paying 4.35% to 7.56%. Actually, these are difficult to buy now because central banks have Corporate Bond Purchase Programs running. Central bands are purchasing bonds on the secondary market to support liquidity and ongoing functioning of the corporate debt markets. In addition, the 7.56% Coupon rates are a strong return in these markets.
Municipal Bond rates in the 5-year range offer 1.65 to 2.15% returns, 20-year municipals are offering up to 5.35%.
CD’s are offering under 1% for short term, just over 1% for 2-year deposits and 1.5% on 5-year deposits.
Remember, the purpose of these investments in your portfolio is to protect against loss of capital and provide stable income.
US inflation is running 1.3%, Canada averages 0.5%, inflation must be factored in when selecting a fixed income investment.
It’s not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for.
Robert Kiyosaki
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