Fixed income securities are investment instruments that offer a specified return at regular intervals. Most fixed income investments are debt instruments, which means you also receive the principal amount upon maturity.
As the name suggests, you are guaranteed a certain return on your investment over time when you invest in fixed income assets. Even when the issuing entity goes bankrupt, its other assets will be liquidated and the income used to pay your principal in full. This safeguards you against risk and potential volatility in the market of other securities.
Also, fixed income investments are liquid; some, like bonds, can be traded for cash in the secondary market. Because they are guaranteed income, fixed income securities come with lower returns. In investments, risk correlates with returns. Low risk often yields lower returns.
The commonest form of fixed income securities is bonds. If you buy a bond from, say a government, you are loaning money to the government up to the amount of your investment. The government then promises to pay you a fixed return at regular intervals until a time in the future when the loan has to be paid back. Some government bonds have very long maturity periods. an example is the US Treasury bond which matures after 20 years. Other short-term bonds are 91-day and 182-day treasury bills.
Apart from governments, big corporations sometimes issue bond certificates to finance large-scale projects. This works like government bonds. The difference is that while government bonds are generally risk-free, corporate bonds carry a small risk. The added risk means corporate bonds pay higher returns when compared to government bonds maturing over the same period.
Corporations also offer a type of stock known as preferred stocks. Unlike common stocks whose dividends vary depending on the company’s profits, preferred stocks carry a fixed return predetermined at the time of issue. These stocks are callable, meaning the company can recall the stocks and reimburse you the full amount of your principal. Preferred stockholders are paid after a company’s creditors but before common stockholders.
A Certificate of Deposit is a promissory note issued by banks and investment houses on fixed-term savings and investment accounts. A bank could offer a 5% interest return compounded monthly if you agree to save with them for a number of years. A predetermined agreement will impose a penalty if you decide to withdraw before the stated number of years.
Fixed income investments are important in ensuring a steady flow of income over a period of time. It is important to have a good mix of fixed income securities in your investment pool to improve liquidity and to provide a buffer against volatility.