We all think about our future and try to plan it, especially after everything that happened last year, and to be able to do so in the best possible way, without worrying about the money, we usually have retirement savings. That is a responsible way of thinking and planning, but since there are a lot of ways to save money, it is always good to know your options. Something that everyone can often hear about is a fixed-income investment, but many people still don’t know what that is, and many people also wonder whether and if so, how risky that way of investing is.
What is it?
The first thing to know is that fixed income investment is a way to ensure a steady flow of money on a regular basis, which usually comes from interest payments from bonds, but there are few other ways of fixed-income investments like:
- Certificates of Deposit.
- Money Market Funds
- Fixed-Rate Annuities
Although it is one of the safest ways to place your money, it still has some disadvantages as one can often get below-average returns on their investments. But unlike the stock market, where one can experience price volatility, the bonds represent a cushion to the investment portfolio, as high-quality bonds will unlikely to get a high price drop.
How investing in bonds works?
There are several ways one can buy bonds, and although an individual investor can purchase them, the most usual way to buy them is via some company. When obtaining a bond, you actually lend money to the company, and you do that for a certain time period (of your choosing). On the other hand, the company guarantees that it will pay you an interest every year, along with the entire amount after the predetermined period – maturity date.
Now, that interest (the money you get) depends on many things, but as it is with all other types of investments, the risk has a huge role, and the higher the risk, the higher the interest rates.
As noted above, we lend money to the company, but in order to do so, we need to know whether we could trust that company, and for that – there is a debt (credit) rating. Some companies offer debt assessment services to provide future investors with all the things they need to know prior to the contract, and by doing so, they represent the idea of the likelihood that they will meet the payment obligations.
There are also several types of bond investments:
- Corporate bonds
- Government bonds
- Munis (Municipal bonds)
- International bonds
Each one of them has its flaws and advantages, but when it comes to how much risk is in any of them, the Government bonds are the best and the ones with the lowest risk for quite obvious reasons. But since buying the bonds of some country can be a pretty complex thing to do, one can do that by mutual funds and ETFs. Those who choose to do so should know that there is a management fee that they will need to pay. Luckily, over the past couple of years, that fee has been reduced a lot, and now it is around 0.5%.
What are the main risks of fixed income investing?
In order to understand the risk of investing in bonds, you need to know that the value of every bond can and probably will change until the maturity date. The good thing is that one can trade it before that date, depending on the current price and whether their value is higher than their nominal value. When someone mentions investing, the first thing that cross peoples mind is the stock market, and although the stock market can bring quick profits, it also comes with more risk.
That is why to get the most out of your investments, maybe the best solution is to follow the example of the “father of value investing” – Benjamin Graham, who came to a conclusion that the best solution is to invest in both bonds and stocks. Reading his books is also a great way to get more informed.
As already mentioned, every type of investment has its risks, and with fixed income investing, there are several of them:
- Inflation risk
- Credit risk
- Lower return on investments
- Liquidity risk (when there is no buyer even when the investor wants to sell them)
As for what will the year ahead of us bring, every expert in this field will say that the price of corporate bonds can only go up in 2022, but there will be some challenges. What we can all witness is that ten years ago, the treasury bond may have offered a yield of around 4%, but today, that percentage is closer to 2%. The last year, with all its difficulties, did not help as well, and as most financial experts state, everything on the economic view will highly be dependent on the trajectory of the pandemic. Of course, that plays a huge role in everything, but since the announcement that there is a vaccine, the interest rates got higher and still maintain that slowly but steadily grow.
Even with all the risks, if we can be certain of one thing is that fixed income investing was, is, and will be a way to place your funds. Due to everything going on in the world, it is quite normal that no one can expect large amounts, and those who decide to go with bonds should prepare to get a yield of around 2%, but once again, it is a much better and safer option than anything else, especially for those saving for retirement. Another great thing is that today, many famous companies offer their services to those who need them, and with reputable websites like räntefonder, everyone can not only find out everything there is to know about fixed income investing, but also get proper guidance on how and where to invest.