A Compehensive Guide to Fixed-Income Investing

Key Takeaways

• Particularly popular among those nearing retirement, fixed-income investing aims at producing consistent, known, fixed payments through lower-risk investments. 

• Fixed-income investments are frequently intermingled with stock investments to establish a more modern portfolio that is less vulnerable to constant market fluctuations.

• Like alternative investments, fixed-income investments may offer protection during short-term market downturns.

Investors looking to diversify their holdings – craft portfolios with varying investments with different expected risks and returns – may want to consider fixed-income investing, especially if they are close to retirement. That calls for first understanding the types, strategies, challenges, and advantages of such investments. With that in mind, here is a guide to fixed-income investing. 

What is Fixed-Income Investing? 

Particularly popular among those nearing retirement, fixed-income investing aims at producing consistent, known, fixed payments through lower-risk investments. 

Such investment assets often include certificates of deposit (CDs), money market funds, municipal and corporate bonds, and Treasury bonds and bills, which are generally less risky than investments such as stocks.

While not risk free, fixed-income assets are often prioritized as the Golden Years approach, since retirees often must depend on their investments for consistent income and do not wish to actively trade based on price changes.

As an example of such an investment, say a company issues a 5% bond with a $1,000 face value that will mature in five years, meaning the investor who buys it will not be repaid until five years past. Over those years, the company makes interest payments based on an annual 5% rate. Thus, the investor gets $50 annually for five years. Once five years are up, the investor gets the original $1,000 investment on the bond’s maturity date. Some fixed-income investments make payments monthly, quarterly, or semiannually.

Understanding Fixed Income Investing

All told, fixed-income investing can be a viable choice if someone is living on, yes, a fixed income and seeking to maximize savings with predictable returns. It can also help the investor avoid a constantly changing stock market, which can provide peace of mind. 

The ultimate goal of fixed-income investing — itself a conservative strategy — is to diversify investments. Fixed-income investments are frequently intermingled with stock investments to establish a more modern portfolio that is less vulnerable to constant market fluctuations.

Stock investments do offer growth over time, but at the expense of volatility. Thus, holdings that contain a mix of both types could meet short- as well as long-term investor needs. How much of a portfolio that should be dedicated to fixed-income products hinges on the investor’s investment style.

Types of Fixed-Income Offerings

Those interested in fixed-income investing have a broad range of products from which to choose, including:

• Federal government bonds. These can include Treasury bills, Treasury bonds, and Treasury notes, and come with varying ranges of maturity. They typically make regular payments of accrued interest.
• Municipal bonds. City, county, and state governments issue these when they must fund major projects such as new schools. While there is some risk of default, an advantage is federal and state tax favorability.
• Corporate bonds. Corporations also need money to grow, and so turn to corporate bonds, which deliver regular income to bondholders. Investors must be certain of the company’s financial health, however.
• Certificates of deposit. Banks and credit unions are happy to pay top dollar for the use of one’s funds for anywhere from three months to five years or longer. There will be a penalty for principle withdrawal prior to maturity, however.
• Money-market funds. These are considered a kind of mutual fund that puts capital in short-term debt securities. While these funds are relatively liquid, returns will go up and down with interest rates. 

How Do You Invest in Fixed Income?

Before deciding on a fixed-income investment approach it is advisable that investors ask themselves how soon they are expected to get their original investment back, and while their money is invested, how frequently they wish to be paid. Once those questions have been answered, the investor can then invest their capital with the goal of regular interest payments during retirement to cover their living expenses.

Common strategies include: 

1. Laddering strategy. Because the risk is comparatively lower with fixed-income investing, so are returns, usually.  Enter what is called a laddering strategy, which provides consistent interest income through the investment in a series of bonds. As the short-term bonds mature, the returned principal gets reinvested into new short-term bonds, thereby extending the ladders.
   
   Such an approach permits the investor to gain capital liquidity and get around missing out on increasing market interest rates.
   
   An example would be if a $60,000 investment is divided into bonds of one, two, and three years. The principle is divided into three equal portions, with the investor putting $20,000 into each of the three bonds. At the maturity of the one-year bond, the $20,000 will be folded into a bond that matures a year after the original three-year period. Upon maturity of the second bond, those funds are rolled into a bond that, for another year, extends the ladder, giving the investor a steady return of interest income and the benefit of any future higher rates.
   
2. Fixed-income mutual funds. These provide exposure to varying bonds and debt instruments that give the investor an income stream while leaving portfolio management to professionals.
   
3. Fixed-income exchange-traded funds (ETFs). In addition to fixed-income securities that can be bought directly, there are a number of ETFs available that work like mutual funds. The difference is that such funds may be more accessible to individual investors, and more cost effective, although there will be a managerial expense. 

Challenges in Fixed-Income Investing

There is no risk-free investment, and that goes for fixed-income investing too. Top risks include:

• Interest rate risk. One of the biggest knocks on most fixed-income investments is interest rate risk. For example, if someone buys a 10-year bond with a 3% interest rate for $2,000, they see that interest rates on a new 10-year bond after three years are at 4%. If the person wishes to sell their bond early, they will be going up against products that can possibly earn better returns, rendering the bond less valuable. 
• Default risk. Risks involved with fixed-income securities include inflation, liquidity, call, credit, and default for issuers as well as investors. With the latter in particular, it is possible the bond issuer will not repay the fixed interest and principal amount. Investors are advised to check a company’s credit rating before investing capital.

Advantages of Fixed-Income Investing

There are a number of benefits to fixed-income investments, including:

• Low volatility. Like alternative investments, fixed-income investments may offer protection during short-term market downturns.
• Income generation. When planning for retirement, removing as much guesswork as possible is usually a goal. With fixed-income investing, the retiree will know how much they have coming in and can plan accordingly.  
• Potential tax favorability.  Not all, but many fixed-income investment products carry prospective tax benefits. Interest income from U.S. Treasurys, for example, is exempt from local and state taxes. Also, earnings from municipal bonds are exempt from federal taxes.

Diversify Your Portfolio Outside of Traditional Assets

Yes, the potential advantages of fixed-income investing are manifold. However, alternative assets are increasingly popular, as investors seek relief from an inherently volatile stock market. Not only do alternatives tend to protect against inflation, and have tax advantages, but they have low correlation to public markets.

That means prospects of steady, secondary income. After all, private markets have performed better than stocks in every economic downturn since 2008. In the last eight years alone, private market opportunities have provided a net annualized return of 9.75, compared to 6.5% in annualized returns for holdings of stocks and bonds. 

An alternative platform on which nearly $4 billion has been invested to date, Yieldstreet is also increasingly popular. It has the most expansive selection of asset classes, with highly vetted offerings in art, real estate, transportation, private credit, structured notes, and more.

Alternative Investments and Portfolio Diversification

Alternative investments also offer another essential benefit: portfolio diversification. Mixing investment holdings with various types can not only potentially improve returns but can reduce overall portfolio risk. In fact, diversifying one’s holdings is key to long-term investing success.

Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $5000.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

Despite the risks — and factoring in an investor’s time horizon and risk tolerance — fixed-income investing can lend some stability to a portfolio mostly made up of stocks, since such assets carry a generally lower risk than equities.

Such investments, as well as in alternative classes, can also be a good way to diversify holdings.