Investing in fixed income is an important but often overlooked part of an individual’s investment portfolio. In this guide we will explore who should be investing in fixed income, how to determine what bonds to invest in, and some basic strategies to consider for fixed income investing.

What is Fixed Income?

Fixed Income is another way of saying bonds. For some, this explanation may not be helpful, and you may be wondering what a bond is. A bond is simply a loan. Instead of you borrowing money from the bank, with a bond you are the bank, and you are loaning your money out to an entity like Apple so they can build the newest iPhone factory, or it could be to a local government to help build a new school. Bonds are called fixed income because you will receive the fixed interest payments over time for a guaranteed period. For example, a local government may borrow the money from you at a 5% annual interest rate. They will pay you back the money in 10 years and meanwhile every year you will receive 5% in interest coupon payments.

Who Would Be an Ideal Candidate for Fixed-Income Investing?

Risk-Averse Investors: Bonds are considered a less risky investment than other investments like stocks, alternatives, or real estate. Individuals who have lower risk tolerance or are looking to invest in safer investments should consider bonds as part of their portfolio. Below is a broad chart just to show the relative riskiness of different investments:

Income Seekers: Individuals like retirees often invest in fixed income because they are looking for investments that can produce stable income to be a source of income for them. With the majority of fixed income, you will know to the penny how much income you will receive each year for the life of the bond.

Diversification: The most important aspect of investing is having proper diversification. Having some bonds as an investment can significantly reduce the potential for losing money, while still having the ability to generate income and strong returns. Below is a chart of the annual returns of global bonds in blue and the global stock market in grey. In the years that stocks underperform, you can see how bonds typically outperform in those years. Having some exposure to bonds allows your portfolio to perform better in down years in the stock market. Simply put, bonds tend to zig when stocks zag.

How Does One Evaluate Which Fixed-Income Investment Is Right for Them?

Risk Tolerance: This is a good starting point. It is important to understand how much risk you are able and willing to take to help determine how much to invest in each asset class. The more conservative you are the more bonds you should have.

Time Horizon: How long are you going to have this money invested? If you are investing for 3-5 years, you should look at bonds that mature (end) in this period. The duration of the bonds you choose often should closely reflect your time horizon. Duration measures how long it takes, in years, for an investor to be repaid a bond’s price through its total cash flows. 

Interest Rate Sensitivity: One of the biggest risks to bonds is interest rates. Bond returns have an inverse relationship with interest rates. This is an important consideration in an interest rate-changing environment. In general, the higher the duration, the more a bond’s price will drop as interest rates rise. 

Credit Quality: Companies and governments have credit ratings just like individuals. The higher the credit rating the safer the bond is through the lens of the credit rating agency. Look for the issuer’s credit rating to determine the likelihood of receiving timely interest payments. A bond with a lower credit rating will give a better return but carries more risks than a bond that has a higher credit rating.

Liquidity Needs: Make sure you have cash available, so you are not forced to sell your bonds when life happens. Or consider buying bonds with different maturities to meet your upcoming liquidity (cash) needs.

What Key Strategies Should a Beginner Consider with Fixed-Income Investments?

Watch the Yield Curve: We have described the relationship between bonds and interest rates already. Pay attention to how bond yields vary across different maturities and choose bonds based on your outlook for interest rates. As an investor, you want to get compensated for the risks you take. Bonds with lower credit ratings and longer maturities typically carry more risk. Below is an example of what the return for bonds looks like at different maturities:

Laddering: The idea of laddering is to buy bonds at different maturities that creates a laddering effect to meet your cash flow needs. For example, if you think you will need money in 24 – 36 months for a home purchase you may want to ladder your bonds at different lengths like 18, 24, 30, and 36 months. This means that you will have access to the money at the end of each bond and you can choose to reinvest the money or use it for other things.

Use multiple types of bonds: Spread investments across different types of bonds (government, corporate, municipal) to reduce risk. It can be beneficial to buy bonds that are short, medium, and long as well for further diversification.

Reinvestment: Bonds typically will pay you interest payments every six months. If you need income, then this is a great source. If you do not need the income it is best to have the interest be reinvested to buy more of the investment so your money can grow even faster.

Work with a Financial Advisor: If you are new to fixed income, consult with a financial professional to ensure the investments align with your goals and risk tolerance.

Fixed income can be a great investment for most people since it is a more conservative way to invest and a good source of income for investors. With bonds make sure you are aware of your time horizon, and expectations for interest rates to plan accordingly. Be aware of the duration of the bond and the credit rating to make sure you are compensated for the risks you are taking. Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by BFSG), will be profitable or equal any historical performance level(s). Please see important disclosure information here.