The world of fixed income securities can appear daunting and complex for most. Especially, in a country like India, where investments in fixed-income assets are considered a luxury only the ultra-rich can afford.
But this statement is far from the truth.
Fixed Income Securities make up the backbone of a well-diversified investment portfolio and act as a steady source of income. They are a safer place to put funds during volatile periods. And as a retail investor, you should know how it can help you achieve your financial goals.
In this article, we break down the basics of Fixed Income Securities. We’ll dive deep into the different types of fixed-income securities, how they work, and whether you should invest in fixed-income securities.
What Are Fixed Income Securities?
Fixed-income Securities pay a fixed amount of money to their holder at regular intervals until its maturity date. The borrower could be the government, corporations, or even banks. After maturity, investors are repaid the principal amount they had originally invested.
This method of investing focuses on one goal: to keep your initial principal safe. It’s a practical approach for most people, who don’t want to take much risk with the money they have set aside for the future but are still looking for growth over time.
Unlike equities, where dividend payments and cash flows can change based on short-term interest rates and market conditions, the payments of a fixed-income security are known in advance and remain fixed throughout.
Some of the most popular fixed income securities in India are Government bonds, bank deposits, public provident funds, and corporate bonds.
Let’s look at some of these fixed income securities examples.
The Different Types of Fixed Income Securities In India
Here are some of the most popular fixed income securities examples.
1. Bank Deposits
Also known as fixed deposits. They can be used for short or long tenures and work similarly to CDs or savings accounts, except that money invested in bank deposits cannot be withdrawn before its maturity period. In exchange, the financial institution will pay the customer the applicable interest rate based on how much they deposit and for how long.
In case of emergencies, premature withdrawal can be made against a penalty.
2. Sovereign Gold Bonds
SGBs are government securities issued by the Reserve Bank on behalf of the Government of India. They are the perfect alternative to investment in physical gold. Since they have Government backing, they are considered quite safe.
With these bonds, an investor enjoys capital appreciation depending on the price of gold and also earns an interest of 2.50% every year. These bonds are also exempt from the capital gains tax if they’re held till maturity.
3. Treasury Bills
Treasury Bills are amongst the safest fixed-income investments available to an investor. Treasury Bills are bought at a discount from their face value.
Upon maturity, if the face value amount of the T Bill is greater than the purchase price, the difference is the interest earned for the investor. And this interest income is exempt from taxes. However, this safety comes at a cost since no regular interest payment is made by Treasury bills.
4. Corporate Bonds
With Corporate Bonds, you lend money to a company. The company can use this money for the development of new products, launching new businesses, or fulfilling their working capital requirement.
Corporate Bonds are considered to be riskier than bank products or treasury securities since they are not backed by the Government, which is also one of the reasons why they typically pay higher interest rates.
5. Public Provident Fund (PPF)
PPF is a long-term investment option offered by the Government of India that provides a fixed rate of return. It is a long-term investment scheme with a lock-in period of 15 years on investment and is popular among people who want to earn high but consistent returns.
They are considered safe and are eligible for tax benefits under Section 80C of the Income Tax Act.
6. National Savings Certificate (NSC)
NSC is another fixed-income investment option offered by the Government of India that provides a fixed rate of return. The scheme’s main goal is for individuals to make small or medium-sized savings, and tax breaks are provided for these savings.
Because the scheme is supported by the Indian government, the risks of investing in it are low.
7. Post Office Time Deposits (POTD)
POTD is a fixed deposit offered by the post office and provides a fixed rate of return. With a few exceptions, it is similar to a bank fixed deposit.
It offers four accounts, each with a different maturity date of one, two, three, and five years.
Individuals can open a time deposit account by visiting their nearest post office or using the official website or app of India Post.
8. Commercial Papers (CP)
Commercial paper, also known as CP, is a short-term debt instrument issued by businesses to raise funds for a period of up to one year.
Commercial papers are typically sold at a discount to face value. It reflects market interest rates at the time. They are considered relatively safe and are used to meet working capital requirements.
- Non-convertible Debentures (NCD)
When a company wants to raise capital from the market with a fixed maturity, it will issue non-convertible debentures. The maturity period can range between 90 days and 20 years.
NCDs cannot be withdrawn before maturity, but they can be traded on the secondary market.
NCDs are corporate debt securities that are not convertible into equity shares. They provide higher returns than bank fixed deposits but are more prone to default.
Now let’s take a look at the advantages of these different types of fixed income securities.
Advantages of Fixed Income Securities
Here are some of the benefits you’ll derive from investing in different types of fixed-income securities.
- Steady Source Of Income Generation
Fixed-income securities are a great way to add stability and growth to your investment portfolio. They offer investors a steady stream of income while simultaneously offering the issuer much-needed access to capital or money in most cases.
- Safety and Lower Volatility
If you’re looking to diversify your investment portfolio, fixed-income investments can be a great way to do it. The interest payments from these products help to stabilize risk-return in your portfolio.
- Preservation of Capital
Capital preservation is an investment strategy that seeks to preserve capital and avoid portfolio loss through safe assets like Treasury bills and CDs. It’ll help you preserve the money you’ll need in the next five to ten years, which is especially important for retirees who are more sensitive to portfolio volatility because they have less time to recover losses.
- Backed By Guarantee
Many fixed-income investments like Treasury bonds, Post Office fixed deposits, and SGBs, have the backing of the Indian Government making them one of the most secure forms of investment.
But all this safety comes at a cost and you need to be aware of the downsides before you plan on investing in these instruments.
Risks Associated with Fixed-Income Securities
Here are some of the risks associated with investing in different fixed-income securities.
1. Risk Due to inflation
Rising prices and inflation pose a risk to fixed-income investors. If prices or inflation rise, the gains on fixed-income securities are reduced.
For example, if fixed-rate debt security pays a 2% return and inflation rises by 1.5%, the investor loses out, earning only 0.5% in real terms.
2. Risk Due to Interest Rate Hikes
Fixed-income investors also face interest rate risk. This happens when market interest rates (the interest rate a bank offers on deposits) rise, causing the rate paid by the bond to fall behind. In this case, the bond would lose value in the secondary bond market. Your capital remains locked in, and you cannot put it to work earning a higher income without taking an initial loss on it.
For example, if an investor purchases a 3-year bond paying 4.5% per year and interest rates for 2-year bonds jump to 7%, the investor is locked into receiving only 4.5%.
3. Risks Associated with Liquidity
Price changes and supply and demand alter the liquidity of a bond. This is the risk that a bondholder might 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 the bond at a price lower than expected or at a price lower than the purchase price.
4. Credit Risks
Although Corporate bonds are considered to be safe investments, they’re not risk-free. When you invest in corporate bonds, you take on credit risk in addition to interest rate risk.
Credit risk (also known as business risk or financial risk) is the possibility that an issuer/borrower could default on its debt obligation. And If this were to happen, the investor may not receive the full value of their principal investment.
All fixed income products come with their fair share of pros and cons. You as an investor should be aware of how they complement your financial goals before opting for them.
Who Should Invest In Fixed Income Securities In India?
Fixed-income securities are suitable for a wide range of investors, including:
- Conservative investors: Investors who are risk-averse and prefer a safe and steady return on their investment may find fixed-income securities to be a good option.
- Investors seeking regular income: Fixed-income securities such as bonds and fixed deposits pay interest at regular intervals, making them a good option for investors who are looking for a regular source of income.
- Investors nearing retirement: Fixed-income securities such as government bonds and public provident funds are considered to be safe investments and may be suitable for investors nearing retirement.
- Investors looking for tax benefits: Some fixed-income securities, such as tax-saving fixed deposits and public provident funds, are eligible for tax benefits under Section 80C of the Income Tax Act, making them a good option for investors looking to save on taxes.
- Investors looking for diversification: Fixed-income securities can be a good addition to a diversified investment portfolio as they have a low correlation with other asset classes such as stocks.
Diversifying your investments, getting dependable income, and reducing taxes are just some of the many benefits of fixed-income investments. They are suitable for conservative investors, regular income seeking investors, and those nearing retirement.
You should consider investing in fixed income securities in India based on your investment goals, risk tolerance, and overall financial situation to build a well balanced investment portfolio.
Frequently Asked Questions
Q1. Is Fixed Income Security a good investment?
Fixed-income investments can help you generate a consistent stream of income. For investors who have less time to recover losses, fixed income can be a smart option because these assets normally carry less risk.
Q2. Is bond a fixed income security?
A bond is a type of debt security that is issued by an organization to raise money for a specific purpose. A bond is called a fixed-income security because you are buying it at a fixed price, and the coupon rate that has been chosen will not change over time.
Q3. Are fixed-income securities safer than equity?
Fixed-income investments pay consistent interest and have lower risk, making them appealing to risk-averse investors. Equities, on the other hand, do not pay regular interest. They can provide high returns but are also riskier.