Fixed interest or fixed income is a type of investment that is usually designed to generate a specific, or fixed cash flow, through interest income or dividends over a set period. The idea of fixed income is that your rate of return is known, so unlike when you invest in equities or most other kinds of investments, your wealth doesn’t fluctuate or fall.
The issuer is obliged to make payments of a fixed amount on a fixed schedule. For example, the borrower may have to pay interest at a fixed rate once a year, and to repay the principal amount on maturity.
For this reason, fixed income assets are often seen as one of the safest forms of investing, as it helps to preserve capital.
Common fixed income investments include Treasury bonds, government and agency bonds, municipal bonds, corporate bonds, and mortgage-backed securities, as well as certificates of deposit and preferred stock or securities.
Why invest in fixed income?
Fixed income investments in a portfolio can provide capital stability, liquidity, regular income and diversify away from equity risk. Essentially, fixed income assets should provide some certainty and predictability, which can be the defensive anchor of a portfolio.
Income
Fixed income investments are designed to generate a consistent stream of income, through interest income or dividends over a set period. Your return is known and predictable.
Improves the stability of your portfolio
Fixed income assets provide diversification, more certainty and predictability of returns, and act as the defensive anchor of a portfolio.
Low correlation to equities
Fixed income returns have low correlations to returns from typically riskier asset classes, like equities. Fixed income investments are less sensitive to macroeconomic risks. For diversification and volatility reasons, its beneficial to include fixed income in a portfolio alongside other asset classes.
Source of liquidity
Fixed income securities can be a close substitute to cash, they can be treated as a source of liquidity.
Benefits of fixed income investments
The key features to fixed income investments that make them desirable to investors: diversification, capital preservation, income generation, and potentially favourable tax treatment.
• Diversification: Adding bonds to an equities portfolio can help lower portfolio volatility over time.
• Capital preservation: Bonds typically have a stated maturity date, when the principal is expected to be repaid. As a result, bonds are designed to protect principal, which can be useful when trying to save for future expenses such as buying a home or retirement.
• Income: Fixed income securities are typically designed to generate a consistent stream of income, often to help supplement an existing income or create one in retirement.
At Fortlake, we have a strong focus on capital preservation.
Capital preservation
Fixed income investments are ideal when preservation of capital is a priority. Specifically, with bonds, principal is usually returned at a set maturity date. Higher-quality fixed income investments, like Treasuries and NCDs, have the best potential for protecting principal. Though preserving capital is a key feature of fixed income securities, there is still the risk that the issuer of the bond will not make good on paying back the principal.