Different investment alternatives are available that differ in their structure and eventual functioning. Some come with a fixed income guarantee; in some cases, the return is not fixed and depends on several underlying factors. Fixed income securities are investment instruments that come with a definite income in the form of periodic interest payments. Moreover, investors also receive the principal amount invested on maturity.
Let’s explore the concept of fixed income securities, its types, working details, the concept and how you can productively use them for maximising gains.
What are Fixed Income Securities?
Fixed income securities are debt instruments issued by a government or corporate organisation offering a fixed return on your investments. These securities act as a liability for the organisations launching them into the market. The returns on these fixed-income investment securities are generated periodically, and the interest payable remains constant irrespective of market conditions.
These investment securities are ideal for investors seeking periodic returns from their investments at low or minimal risks.
Example of Fixed Income Securities
Now, let’s see an example that will further clarify your understanding of this concept. Suppose you decide to invest in a government bond, a fixed-income security. The price of the respective government bond stands at ₹15,000. The interest rate on this bond stands at 5%, and the total maturity period is 10 years.
The coupon or interest payments will be given on a half-yearly basis. If you decide to buy out this type of bond, you will have to pay ₹15,000 to the government on an upfront basis. Moreover, you shall receive ₹750 twice a year as the interest payment cycle is half yearly.
The government will continue to give out the interest amount to you for a period of 10 years, which is the maturity cycle. After the completion of the maturity period, the government will repay the full ₹15,000 that it had received as an upfront payment from you.
Types of Fixed Income Securities
Here are the different types of fixed-income securities in which you can invest:
1. Certificate of Deposits
It is a money market instrument that a bank issues which guarantees repayment of principal along with a pre-specified interest rate. Generally, the rate of return in a certificate of deposits is not quite high. However, it is higher than a savings account, so you can look to put your money in these instead of parking funds in a normal savings account.
2. Treasury Bills
T-bills are short-term fixed-income instruments that are issued by the government for 91, 182, or 364 days. These are issued mainly to raise money for meeting the expenditure. It comes with a maturity period of one year. T-bills are generally issued at a discounted value but repaid at par value.
3. Bonds
Bonds are other popular fixed-income securities offering predetermined returns issued by the government and corporations. The companies issue bonds to fund the day-to-day expenses to ensure a smooth production run.
4. Debt Mutual Funds
Debt Mutual Funds use the accumulated corpus for investment in various fixed-income securities such as money market instruments, bonds, T-bills, etc. These funds offer high returns compared to regular saving schemes such as Recurring Deposit and Fixed Deposit.
5. National Savings Certificates
NSC can be brought from any Post Office across India. You can buy an NSC in your name, jointly or even under the name of a minor. NSC comes with a fixed maturity period of 5 years or 10 years and a fixed interest rate.
The minimum amount to buy an NSC is ₹100, and it also offers tax benefits up to ₹1.5 lakh under section 80C of the Income Tax Act 1961.
6. Fixed Deposits
Fixed Deposit offers safe and guaranteed returns and higher interest rates than a savings account. FDs come with a lock-in period and can be availed for both short and long-term goals, wherein you can invest a specified amount for a tenure based on your financial goals at fixed interest rates.
7. PPF
This is a central government-sponsored fixed-income security. It offers interest on an annual basis on the total amount invested in the security. It is quite beneficial as it offers interest income and facilitates tax benefits for investors. The interest in these schemes is quite higher than in other similar schemes.
Who Should Invest in Fixed Income Securities?
As the name suggests, these instruments offer their investors a relatively risk-free fixed income. Therefore, it becomes an ideal investment alternative for conservative investors who are contending with moderate returns and the safest tool to invest. These investors are wary of the fluctuations occurring in stocks and equity-related instruments and do not want to risk their hard-earned money in that.
Moreover, these securities can be a good investment option if you want to diversify your portfolio. This is because it will provide a stable flow of income even when other investments of your total basket suffer some setbacks or do not yield sufficient returns.
Senior citizens can also look for such securities while looking for alternative sources of investments.
However, investing in fixed-income securities might reduce the real value of the money invested, as no adjustments are made against inflation.
Benefits/Advantages of Investing in Fixed Income Securities
Some benefits of fixed-income security investment are as follows:
1. Regular Returns
One of the biggest advantages of investing in these instruments is that it provide a regular and consistent income for the investors. This helps investors to plan their different financial activities better as they are sure of a certain return from these instruments. It offers certainty and surety in financial planning and management.
2. Portfolio Diversification
These securities go a long way in diversifying the investment basket of investors. Incorporating these instruments in your investment basket helps in maintaining a balance of your investment basket. This is because an inverse relationship exists between returns from equity instruments and fixed-income instruments. Therefore, if returns from equity go down, these fixed securities will be your saviour and prevent a degradation of your investment portfolio.
3. Low Risk
Low risk When compared with other investment instruments like equities, derivatives, real estate, and mutual funds, fixed-income securities score lower on the risk factor. They come with the least risk as compared to all the above-mentioned instruments. As a result, it becomes quite an ideal investment instrument for investors wary of market fluctuations and content with moderate to low returns.
4. Credit Rating
All fixed-income instruments come with a credit rating given by an independent and impartial credit rating agency. These credit ratings help investors to make an informed decision based on the creditworthiness of the respective issuing entities.
5. Preference in case of Insolvency
Another benefit of these instruments is that creditors of these income securities will be given first preference in terms of repayment whenever the issuing entity undergoes insolvency proceedings. Therefore, it acts as another safety net that even if the corresponding organisation collapses, there is still a way of minimising overall losses.
Disadvantages of Investing in Fixed Income Securities
Although these instruments are quite beneficial for investors due to a number of benefits arising from the same, there are some drawbacks as well.
1. Interest Rate
As the interest income from these instruments is fixed, investors of these instruments may miss out on the benefits of rising market interest rates. When the interest rates of new securities increase, existing securities become less lucrative for investors. They will opt to put their money in new securities rather than older ones at low interest rates.
2. Low Liquidity
The liquidity of these fixed-income instruments is lower than that of equity and related instruments. It becomes difficult to find a new buyer or seller and carry out transactions because there are several things that affect the functioning of fixed-income securities. This includes general market interest rates, such securities’ credibility, repayment terms, etc.
Things To Considering Before Investing in Fixed Income Securities
Here are some things that you can consider before investing your hard-earned money in these instruments:
1. Investment Goals
It is important that you consider your investment objectives and analyse whether it is aligned with what the fixed-income security is offering. If you are satisfied that the concerned fixed-income security is in sync with your overall investment goals, consider investing in it.
2. Risk Appetite
Another thing that you may consider is your risk appetite. These instruments are ideal for low-risk or conservative investors. Investors with high risk tolerance might not prefer this investment instrument because of its limited returns.
3. Credibility of Issuing Entity
Another thing that you need to look into is the credibility or creditworthiness of the issuing entity. You should consider investing in only those securities with a high credit rating or issued by entities with high credibility in the industry.
Conclusion
Fixed income securities are efficient financial instruments that provide safe and guaranteed income for investors. It is quite popular among conservative investors who are looking for a nominal but stable flow of income. If you want to invest in these securities, you should conduct a thorough market analysis and decide on the instrument after due diligence and consideration.
FAQs
No, that is not the case. Although moderate, there are certain risks associated with fixed-income securities. Borrowers can default on their interest and principal obligations. Moreover, investors may face interest rate risk in times of rising interest rates.
A steeply rising inflation can deeply impact the returns from fixed-income securities. This is because you have invested in security, which provides a return of 5% per annum. However, the CPI or inflation prevailing in the economy is 7%. Therefore, the real return gets down to -2%.
Having a Demat account is mandatory for investing in some types of fixed-income securities like bonds, treasury bills and government securities. There are several instruments like NSC, PPF, etc., which do not require a Demat account.
The most significant difference between fixed and floating interest rate securities is that the former provides investors with a definite and guaranteed return. However, returns from the latter depend on prevailing market rates. If it is rising, the return will also increase, but if the market rates are falling, returns shall fall or decline rapidly.
Yes, there are fixed-income mutual funds whose aim is to invest in different types of fixed-income securities and generate interest income for investors. The yield received by the investor depends on their proportion of investment.
Disclaimer
This article is solely for educational purposes. Stable Money doesn't take any responsibility for the information or claims made in the blog.
