Fixed Income can be a very important investment class by which one can diversify his/her portfolio to reduce risk.
Putting all your money into equities (read more about equity investment) can give you more returns but it does carry high risk as well. Diversification is a basic concept of financial planning and fixed income products come in handy to help us achieve this objective.
Let us see what are the different types of fixed income securities and how they help savvy investors who chose to put money in them.
How they work
When you buy a fixed income instrument, you are essentially lending money to a borrower. Money does not come free so you would expect something in return from the borrower.
The borrower issues out interest payments to you which could be paid either annually, quarterly, monthly or any other frequency that is pre-decided. These interest payments are called coupons. Since these coupons are fixed in nature, these instruments are called fixed income instruments.
The borrower also promises to return the money he borrowed from you. So, apart from a consistent income in the form of coupons, you also get your principal back.
Such products are available for different maturities and credit ratings. They are available in India through government schemes, company bonds and fixed deposits.
Advantages
- These securities are very safe in nature. Since the risk is low, the returns are also very low. Investors who are looking to diversify into safe avenues should invest in these. Safety with low volatility are the main features of these products.
- The coupons serve to offer a regular income at very low risk. These become ideal for risk averse investors, for example, people who have retired.
- Such products are available for different maturities, so an investor can buy one by timing the exit of his investment from the instrument when he needs the money.
- Such instruments are very liquid. In case money is needed very urgently by the investor, these can be converted into cash immediately.
Different types
The list of such instruments in India are :
- Fixed Maturity Plan (FMP)
- Company bonds
- Fixed income mutual funds
- Fixed deposits – bank and company
- Public Provident Fund (PPF)
- National Saving Certificate (NSC)
- Post Office Monthly Income Scheme (POMIS)
Note that when it is said that such securities are risk free, it does not mean that they carry no risk. In fact, when choosing such products, the following risks need to be kept in mind :
- Interest rate risk
- Liquidity risk
- Inflation risk
- Credit Default risk
Every investor should always invest some amount of his money in such products based on his time horizon and risk tolerance level. Safety and consistency of returns of such products are logical reasons for an investor to add these products to his portfolio.
We will delve into each of these in future posts.
Nice one! I will be looking forward to follow-up articles.
You mentioned that “Every investor should always invest some amount of his money in fixed income products based on his time horizon and risk tolerance level”
Could you give a ideal distribution between equity and fixed income instruments for a 30 year old, married and one kid? Someone told me that the distribution can be such that (100-age)% should be invested in equity, rest in fixed income/debt.
Another question is real estate? Where would you classify real estate investments? Can real estate be classifed as “equity” instruments?
@D. Bahroos,
The 100-x fundamental is a thumbrule (https://www.thewealthwisher.com/2010/05/25/the-100-x-thumbrule%E2%80%A6/). You are correct in your assumption about your investment into equity and debt in the ratio of (100-age) and (age) resp.
Real estate is not equity. Equity is only stocks and (equity) mutual funds. If you look at https://www.thewealthwisher.com/2010/06/23/investment-avenues-for-indian-investors/ you will see that real estate and equity are classified as separate investment classes.
I will cover equity in my next article (hopefully) for you.
I will also do a article on portfolio allocation for a 30 year old across ALL investment classes.
By the way, how do I address you as ?
Thanks for your interest in my writings.
Oh wow, would be lovely to see an article on equity soon. You could address me as Ravi or Rahul ;-).
Very basic information. Are bonds same as fixed income securities ?
Yes they are same.
Interest rates have been reduced on fixed deposits.Where can I now invest?
Are you asking which FDs to choose at this point of time ? What is your exact requirement ?
Ok, a different ques: Who’s ur fave economist?
None in particular, who is your favourite ?
Adam Smith,the father of Economics.
Do you favour a capitalist or a socialist economy and why?
Can you please help me out by explaining to me how futures and options are traded in real market, please explain to me with real examples…i am new to trading so i need to learn….
Thanks,
Arif Pathan
F and O ? Vow, why go near it ? Do you really need to invest in F&O to make money ?
Excellent basic knowledge. Let me know how company’s find its percentage apart from coupon. Means how they calculate their interest rate…for trade.