What are Fixed-Income Securities?
Fixed-income securities are debt instruments that pay returns to investors in fixed, regular payments and the eventual repayment of principal upon maturity.
Fixed-income securities help mitigate risk in investment portfolios. The stock market can be highly volatile, but fixed-income securities with their nature of steady returns tend to bring this risk to manageable levels acting as a counterweight to equities.
Types of Fixed-Income Securities
Bonds
Government bonds: When you buy a government bond, you lend money to the government in exchange for an agreed-upon interest rate. Governments use them to raise money for infrastructure or new projects, while investors receive a fixed interest return paid regularly.
Corporate bonds: When you buy a corporate bond, you loan money to the business issuing the bond. The business then makes regular interest payments to you, until a future maturity date, when the principal loan amount is repaid too.
Municipal bonds: Municipal bonds are issued by the state or local governments. They are issued primarily to cover capital expenses for building roads, bridges, or schools. Same with corporate and government bonds, the investors or bondholders are promised periodic interest payments and their principal repaid by maturity.
Treasury Bills
Treasury Bills (T-Bills) are the safest short-term debt instrument that a federal government can issue. T-bills are very liquid and a great option for investors looking for a 12-month investment period.
Learn more about Treasury bills in Nigeria.
Certificates of Deposit (CDs)
A certificate of deposit (CD) is a type of savings account where the issuing bank pays interest in exchange for holding a specified sum of money for a predetermined period. You get the amount you invested plus any interest when you cash in or redeem your CD.
Learn more about Certificates of Deposit.
Commercial papers
Commercial papers are unsecured, short-term debt issued by corporations. They are often used to finance short-term liabilities like payroll, accounts payable, and inventories.
Learn more about Commercial papers.
Floating rate notes
A floating rate note (FRN) is a debt instrument with a changeable interest rate. An FRN’s interest rate is linked to a benchmark rate. Financial organizations, governments, and businesses can issue floating rate notes with maturities ranging from two to five years.
Characteristics of Fixed Income Securities
Risk and return
There is a trade-off between risk and return; the more risk you take, the higher returns you should expect. In the spectrum of riskiness, cash tends to sit at the bottom of the list, followed by government bonds that do not have as much risk. Corporate bonds sit at a higher place on the spectrum, but they promise higher returns.
Credit quality
Bonds are also divided into investment-grade and non-investment-grade categories based on credit risk (high-yield or speculative bonds). Bonds with an investment-grade rating have minimal default risk. Non-investment grade bonds, on the other hand, are regarded as low quality since they have comparatively larger default risk.
Maturity
Maturity is the day on which the issuer is required to redeem the bonds, and Tenor is the time left before maturity. Tenor is significant since it shows the investor when to expect payments and how long it will be before the bond is redeemed.
Yield and coupon rate
A bond’s yield is the rate of return it creates, while its coupon rate is the amount of interest it pays each year. The coupon rate on a bond is given as a percentage of the bond’s par value.
Investing in Fixed Income Securities
How to buy fixed-income securities
Investors can buy fixed income through exchange-traded funds and mutual funds. Additionally, investors can purchase newly issued government bonds through auctions, which take place sometimes a year.
How to buy fixed-income securities through mutual funds on Cowrywise
- Download the Cowrywise app
- Create your account or sign in to your existing account.
- Tap “Invest”
- Then choose your preferred mutual funds option.
Our mutual funds’ composition includes fixed-income securities.
Pros and cons of investing in fixed-income securities
Pros
Stability: The stability of returns that fixed-income securities provide is one of the main advantages of investing in them. The returns are constant because they have a fixed interest rate. They are thus a great replacement for bank savings accounts, which pay very little interest on your deposits.
Less risk: When compared to investing in equities, the capital in fixed-income security is at a lesser risk. Due to the government’s backing of some of these instruments, such as treasury bills and government bonds, the likelihood of defaulting on the payment of interest and principal is virtually nonexistent.
Portfolio diversification: A concentrated portfolio of equities can benefit greatly from the diversity provided by investments in fixed-income instruments. It is common knowledge that equity investments yield far higher returns than debt securities, but the volatility of the former’s returns is much larger than the latter. A good mix of both, therefore, ensures stable returns on your portfolio.
Priority during liquidation: When a business declares bankruptcy and liquidates itself, it owes money to its creditors first and stockholders. If it does not have enough assets to cover both, equity holders lose out to the lenders that hold corporate bonds of the company. This is just another factor supporting the notion that debt instruments are a secure form of investment.
Cons
Currency devaluation: One of the cons of fixed securities is that inflation may devalue your money.
Principal/Credit risk: The borrower’s potential for debt default is one of the main risks connected with fixed-income instruments. These risks are reflected in the interest rate or coupon that the security offers, with securities having a larger default risk providing investors with higher interest rates. In other words, credit risk is when the issuer of the bond fails to make timely principal and interest payments.
High entry barrier: Some fixed-income investments have high minimum investment requirements, which means not everyone would be able to access them. However, on Cowrywise, from as low as $10 you can invest in mutual funds with fixed-income securities.
Conclusion
Fixed-income securities do not represent ownership in a corporation, and they differ from equities in that they have seniority of claims over interests in the event of bankruptcy. Also, fixed-income securities can significantly lower your portfolio’s volatility, especially for older people who are approaching retirement and can’t afford to take any risks.
Remember to seek professional advice from experts before you head straight into investments of any kind.
