Introduction of Fixed Income Funds
Fixed Income Funds are financial instruments or securities that give the investors a fixed income over the period of investment, and on maturity, the principal investment is repaid to the investors.
Fixed income funds refer to the investments that pay the investors a fixed income in the form of interest or dividend until the period of the maturity date. At the time of maturity, the principal amount is repaid to investors along with the income component. (e.g.) Corporate bonds, Government and treasury bonds, Certificates of deposit, etc. Fixed income securities are issued to raise funds to manage the financial requirement of corporate and the government.
Fixed income securities are more suitable for conservative investors who want to secure their capital and earn income from the investment. Even moderate risk-tolerant investors choose to invest in fixed income securities to some level in order to balance their risk and returns. They predominantly invest 50% in Equities and 50% in fixed-income securities. Risk is low in these investments, so comparatively, returns are also low, and the amount of income will also be known to the investors.
Features of Fixed Income Funds
- It is a low-risk investment and secures the capital of the investor.
- It gives fixed, regular returns to the investors in the form of interest or dividend.
- It is more suitable for conservative investors who tend to avoid risk. It is more popular among retirement portfolios.
- It reduces the risk in the portfolio of the investors who also invests in stocks.
How does Fixed Income Funds Work?
Fixed income funds are issued by the government, corporates, banks, financial instruments, etc. They are issued to seek funds from investors, and in turn, they pay regularly to the investors in the form of interest or dividend.
Zen Corp floats a fixed-income bond for the expansion of the business. They issued the 5% bond with the face value of $1,000/ bond, and it matures in 5 years. The funds are used in funding the new business segment.
Mr. X bought 10 bonds of Zen Corp and invested $10,000 ($1,000 * 10). He will receive $500 (10,000 *5%) every year from Zen Corp as interest until maturity. (i.e.) for 5 years. The interest amount is fixed and paid regularly every year until maturity. Upon maturity, Zen Corp will repay the principal amount of $10,000 to Mr. X, and on this investment, Mr. X earned $2,500 ($500 * 5 years) as interest income over 5 years.
Types of Fixed Income Funds
The government and corporates usually back it. Some of the common income funds are mentioned below.
- Treasury Bills: It is short-term fixed-income security that usually matures within one year. It is issued at a discounted price, and on maturity, the face value is paid. The difference is the income earned from the treasury bills.
- Treasury Notes: It is a long-term investment varying from 2 to 10 years. It pays a fixed interest over the period of investment, and on maturity, the principal investment is repaid to investors.
- Treasury Bonds: It is a very long-term investment with a maturity period of 20-30 years. It pays a fixed income to the investors in the form of interest, and here also the principal is paid to investors on maturity.
- Corporate Bonds: Corporates issue it. The price and interest rate varies from one corporate to another. It is issued in various forms. Usually, a higher credit rating company offers low-interest rates since the investment is more secured than other companies.
- Certificate of Deposit: It is a fixed income instrument offered by banks and financial institutions and with a maturity period of less than 5 years. The interest rate offered is higher than the savings A/c interest. It is also one of the secured investments.
- Fixed Income mutual funds: It is a specific investment by mutual funds into bonds and debt instruments that pays fixed income in the form of interest. The portfolio managers will charge the professional fees for managing the funds, and the fixed income received will be transferred to investors.
Why Invest in Fixed Income Funds?
Fixed income funds are secured investments and suitable for investors who are risk-averse. The returns will be lower than equity investment, but the capital is protected. It is preferred by investors who look out for stable income from investments and want to protect their money.
Benefits of Fixed Income Funds
Some of the benefits are given below:
- It offers investors a steady source of income over the period of the investment in financial instruments like bonds or debt instruments.
- It gives a more stable income than stocks.
- It is more useful for people at the retirement age and wants to secure their retirement funds and get a decent income.
- These investments help reduce the risk in the investor’s portfolio, which also invests in some risky securities.
- It is used for diversification in the portfolio.
- It is a more secured investment like government bonds backed by the government, whereas corporate bonds may not be that secured, but still, in liquidation or bankruptcy, bondholders have a higher claim on the company’s assets than to shareholders.
Some of the disadvantages are given below:
- Not all fixed-income funds are secured; corporate bonds are not secured as treasury bonds.
- Returns from fixed income securities are lower than the returns given by stocks.
- Corporate bonds are subject to credit risk, and it can even affect the valuations of the bond/ security.
- If bonds are sold even before maturity, it will be sold at market price, and there can be changes where the bond may fetch a lower value than the principal investment and can incur a loss.
- Interest rate risks are associated with the investment. In certain situations, interest rates in the market can keep rising, whereas the bond still pays a lower fixed interest to the investors; in that case, it loses market value.
- The prime purpose of fixed income funds is that the investors getting a fixed income from the securities. If the inflation rate increases and the income from the security being the same, the investor may not get more gains from investment.
Fixed income funds are a good investment for conventional investors and for those who want to reduce their portfolio risk. They get fixed returns from the investment, and the principal investment is also protected. Every investor invests some part of their money in low-risk investments to balance the risk and returns. Fixed income funds don’t fluctuate much like equities, and it is not affected like equities due to market risk. Though the returns are comparatively lower than equities still it chosen by investors for its own merits.
This is a guide to Fixed Income Funds. Here we also discuss the introduction and how does fixed income funds work? Along with benefits and disadvantages. You may also have a look at the following articles to learn more –