The evidence is convincing — more and more investors are moving into bond funds.
In January of 2018, $36.7 billion was invested in bond funds, which puts investing on a pace to reach record levels. Many experts predict an end to the 30-year bull market in bond speculation, but rank-and-file investors are ignoring the advice of bond gurus because of the flexibility, diversity, and safety of fixed income investments.
What Is Fixed Income Investing?
Fixed income investments rank as one of the safest investments because they provide reliable returns and a dependable source of regular income. Your principal is preserved, and many fixed income funds offer substantial tax advantages.
Fixed income funds are ideal for diversifying your portfolio. These investments can smooth out the highs and lows of higher risk/higher reward investments. Fixed income investors don’t earn an ownership share of the companies in which they invest. The investors serve as lenders and are considered creditors, which means they have a higher claim on resources if the company goes bankrupt.
“Fixed income” funds are named as such because they generate a specific level of interest income. These funds include Treasury bonds, agency bonds, municipal bonds, preferred stocks and securities, certificates of deposit, and managed accounts. Bonds are the most common type of fixed income investment, and they are available as federal, state, municipal, and corporate bonds. Although must bonds generate interest at steady or fixed rates, junk bonds, or high-yield corporate bonds, offer greater risk and higher yields.
What Type of Fixed Income Funds Are Available to Investors?
There are a vast number of fixed income investment vehicles from which you can choose. Each type of investment has its own unique benefits and risks, so you should research your investments carefully.
The public bond market recognizes three top rating agencies that determine the credit worthiness of various bond issuers. These rating agencies include Standard & Poor’s Ratings Services, Moody’s Investors Services, Inc., and The Fitch Ratings Group. The term “AAA” is the highest rating, and “CCC” is the lowest except for “D,” which indicates the company has defaulted on a past obligation.
Some of the most popular fixed income investments include the following:
Individual Bonds
Individual bonds can be government bonds, corporate bonds, or project bonds, which are often funded by both corporate and government sources. Bonds are issued by companies, municipalities, and government agencies, but they are subject to the same rules as in any investment. The longer the bond term, the greater the risk to the investor will be. However, Treasury and other government bonds are usually reliable. Companies and governmental agencies are all rated for creditworthiness the same as consumers.
Floating-rate Funds
These funds invest in bank loans, which are traditionally secure, but they offer higher yields for investors when interest rates are rising. When the rates on loans are adjustable, interest rates go higher.
Certificates of Deposit, or CDs
Bank deposits of certain amounts for guaranteed periods of time earn higher interest rates than money deposited in regular checking or savings accounts. These savings options are called certificates of deposit, and they have the advantage of being insured by the FDIC, which increases investment safety.
Preferred Stocks and Securities
Preferred stocks and securities share some of the characteristics of both stocks and bonds. They can provide a fixed income, but the par value can rise and fall. These investments tend not to increase in value like common stocks, but they pay dividends and interest to investors before dividends are paid to regular stockholders.
Managed Accounts
Asset management firms can manage a group of stocks that you own as separately managed accounts, or SMAs. You must usually work with your management firm to agree on which stocks to group together. SMAs deliver some of the same benefits as mutual funds, but you have greater freedom to impose restrictions on management and limits on gains and losses.
Mutual Funds
Mutual funds pool investments in four types: money market funds, equity funds, fixed income, or bond funds and hybrid funds. These investments are usually safer than other mutual funds, but they generate lower returns.
Short-term Bond Funds
Investors who don’t want to invest in long-term bonds can still realize higher interest than CDs typically yield by investing in short-term bond funds. These can be especially attractive when interest rates are rising because the funds generate less risk. You’re not locked into a low interest rate for long, so many investors prefer this method of bond investing.
Benefits of Fixed Income Funds
Fixed income funds are useful for diversifying your portfolio and providing a relatively safe and reliable income. Any investment can fail, however, so investors should always research the risks. Some funds are more volatile than others, and like most investments, greater risks usually generate greater rewards.
The major benefits of fixed income investments include:
- Providing steady income
- Preserving principal to save for a predefined future expense such as buying a business or a home
- Enjoying tax advantages such as exemption from federal taxes
- Enjoying exemption from state taxes in some cases
- Receiving a higher claim on company assets if the company fails
- Lower management fees
- Flexibility to invest in asset-backed, mortgage-backed, and government-backed securities or high-yield corporate bonds, emerging markets and investment-grade corporate bonds
There are many fixed income investments from which to choose, and you can manage your own portfolio or hire an asset management company. Periodic interest provides a steady income, or you can invest your gains back into the fixed income investment. You can also get the benefits of in-depth research at mutual fund companies because they typically research even smaller companies that aren’t rated by the major ratings agencies.