Fixed Income

KEY NOTES

• Government and corporate bonds are the most common types of fixed-income products.

• For most investors, stocks and bonds go together like peanut butter and jelly. They’re the two main pillars of a well-balanced portfolio, the key ingredients in your long-term wealth.

• Many people shift their portfolios toward a fixed-income approach as they near retirement, since they may need to rely on their investments for regular income.

TYPES OF FIXED INCOME PRODUCTS

• Treasury Bills (T-bills). Short-term fixed-income securities that mature within one year that do not pay coupon returns. Investors buy the bill at a price less than its face value and investors earn that difference at maturity.

• Treasury Notes (T-notes). Come in maturities between two and 10 years, pay a fixed interest rate, and are sold in multiples of $100. At the end of maturity, investors are repaid the principal but earn semiannual interest payments until maturity.

• Treasury Bonds (T-bonds). Similar to the T-note except that it matures in 20 or 30 years. Treasury bonds can be purchased in multiples of $100.

• Treasury inflation-protected securities (TIPS). Protect investors from inflation. The principal amount of a TIPS bond adjusts with inflation and deflation.

• Municipal Bonds. Commonly called munis, state governments, municipalities or other governmental agencies issue this form of fixed income. Muni bonds can have tax-free benefits to investors as well.

• Corporate Bonds. Corporations sell these types of fixed income securities. The yield typically depends in part on the creditworthiness of the issuer. The higher the credit rating, the lower the coupon rate.

• High yield Bonds. Also known as junk bonds, these securities are typically issued with higher coupon rates than investment-grade bonds due to lower credit ratings and greater risks of default.

• Certificate of Deposit (CD). A fixed income vehicle offered by financial institutions with maturities of less than five years.

FIXED INCOME ADVANTAGES

• Diversification. Investors never want to have their eggs in one basket. It is true that stocks tend to beat bonds over the long haul, but you’re better off moderating your risk, especially in the near term.

• Income Generation. Due to the fixed coupon payments that investors receive at specified intervals, bonds can provide a steady and predictable flow of income.

• Corporate Preservation. Bonds make sense for money that you’ll need in five–to–10 years, an important consideration for retirees who are more sensitive to portfolio volatility as they have less time to recoup losses.

FIXED INCOME RISKS

• Interest Rate Risks. Fixed income securities are very sensitive to changes in interest rates. When rates rise, bond prices fall. Conversely, when rates fall, prices rise.

• Inflation Risks. Bonds provide a regular income stream, but the purchasing power of this income can deteriorate when inflation rises.

• Credit Risk. Credit risk is the extent to which a company might be likely to default, in which case the bondholder could lose some, or all, of their principal.

• Liquidity Risks. This is the risk that a bondholder may be unable to sell a fixed income security due to a lack of buyers. In an illiquid market, an investor may be forced to sell at a lower price than they paid for the investment.