Fixed income securities, as the name suggest, are financial investment instruments in which you get pre-decided, fixed, and timely payout of interests for the duration of your investment. Read this article to know more about fixed income securities options available to investors.
Fixed Income Securities
Fixed-income security is a debt investment vehicle that returns in fixed periodic payments and then the return of principal at maturity. Unlike other investments, payments remain the same and do not vary because of the short term interest rates. Bonds are the most common types of fixed-income security, but others include CDs, money markets, and preferred shares. A bond is an investment product issued by corporations and governments to raise capital. It can have different maturities and face values.
Benefits of Fixed-Income Securities
These have a fixed interest rate. Thus returns are more or less steady. Therefore, it provides a steady income to investors throughout the life of the bond. The higher returns make them better than bank savings accounts which give a minimal interest rate on deposits.
Safety of Investment:
The invested capital is at lower risk when compared to investment in equities. As some of these instruments are backed by the Government, the chances of defaulting are almost nil. Also, most of them are highly rated by credit rating agencies, making them the safest investment avenues available in the market.
Equities are more volatile than bonds; as a result, investors allocate some part of their portfolios to bonds to reduce the volatility that comes from equity. One should note that the prices of bonds can increase and decrease.
For instance, if investors sell the bonds before maturity, there could be profit or loss due to the difference between the buy and sell price. Investors receive the bond’s face value at maturity.
Priority at the time of Liquidation:
Corporate bonds are more likely to be repaid than other investments, but if a company declares bankruptcy and must liquidate its assets, bondholders will be repaid before common stockholders.
Risks associated with Fixed-Income Securities:
Investors must weigh the pros and cons before investing in fixed-income securities. Although there are many benefits and are often considered safe and stable investments, some risks are associated. One should remember that Fixed-income securities typically pay a lower rate of return than other investments such as equities.
Interest Rate Risk:
If interest rates increase faster than fixed-income security, investors lose out by holding the lower-yielding security. Thus, fluctuations in interest rates affect the bond prices and affect the returns from debt mutual funds.
Credit Risk :
Credit risk, a.k.a. default risk or business risk, is the possibility that an issuer could default, and in this case, the investor may not receive the total value of their principal investment. To mitigate credit risk, investing in those mutual funds that invest in securities with high credit ratings is advisable.
- Inflation risk:
If the inflation rate outpaces the fixed amount of income, the investor loses purchasing power.
- Liquidity risk:
It is the chance that an investor might not be able to sell a fixed income asset because they’re unable to find a buyer.
Why Invest in Fixed Income Securities?
Fixed income bonds are best for the ones looking for the safest tools to invest. People afraid of stock market fluctuations and looking for risk-free investments to spend their hard-earned money should opt for Debt Mutual Funds.
It can be chosen by an avid investor looking to earn secure returns and aiming to diversify one’s portfolio. In this way, a person can have a stable flow of dividends during a market downswing.
Types of Fixed-Income Security in India
Bonds are issued by corporations and the Government to raise capital for financing new projects. They are issued at face value which is the discounted price, and traded in the secondary market. One earns guaranteed profit, as the bonds are redeemed at face value upon maturity.
Debt Mutual Funds
Debt Mutual funds pool the money from investors and invest it in various debt instruments. These instruments guarantee fixed returns for the investor. As these funds are invested with good research in debt securities, the chances of default of payment on these securities are negligible.
The Central Govt issues T-bills which have short term maturities up to one year. They are the safest short term investments as the GOI backs them.
Bank Fixed Deposits (FD)
FD is one of the most popular investment options available in India. It offers a fixed interest rate on your principal investment. This is provided by almost every scheduled bank in India. One invests a lump sum amount that earns interest which the investor receives at the time of maturity.
Recurring Deposits (RD)
Recurring deposits are similar to SIP Investment. One deposits a small amount of money as a monthly instalment for a fixed duration where the interest rate is identical to that of fixed deposits. It enables a person to create good wealth in the long run with small amounts of monthly payments.
Repurchase Agreements (Repos)
Repos are a formal contract between two parties, where security is sold, with the promise of repurchasing it later.
The buyer buys the security, which includes the interest payments agreed by the buyer. Repos come in handy when the seller needs funds for the short term.
NATIONAL SAVINGS CERTIFICATE (NSC)
It is a fixed return instrument backed by the GOI where one can buy NSC certificates from any post office in the country. NSCs has 2 options for maturity periods- 5 and 10 years.It also qualifies for tax benefits under section 80C of the Income Tax Act, 1961. Just like the other fixed-return instruments, returns offered by NSCs are latent to market fluctuations.