Gail Bebee is the author of No Hype – The Straight Goods on Investing Your Money. She can be reached at gbebee@gailbebee.com; her website is www.gailbebee.com. This is part six of a 12-part series for people that are new to investing on their own.
Fixed income: A type of investing or budgeting style for which real return rates or periodic income is received at regular intervals at reasonably predictable levels. Investopedia
I must confess that I left the topic of fixed income until now because I find the subject boring. However, that is as it should be. Fixed income is the financial Rock of Gibraltar of investment portfolios – an unadorned, indestructible mass that provides stability through the good times and the bad times, like 2008.
While fixed income choices abound in today's world of financial engineering, I think direct investors should stick to fixed income investments that deliver low risk, predictable returns. That means investment quality government and corporate bonds, guaranteed investment certificates, T-bills, high-interest savings accounts, government savings bonds, mortgages and mutual funds and exchange-traded funds which invest in such assets. Forget the complex fixed income products you don't understand. I'm sure the folks who bought “safe” fixed income asset-backed commercial paper would agree. It really wasn't safe and there was no income!
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In this article I'll focus on bonds since new direct investors will be less familiar with this area of fixed income.
A bond is a debt instrument that is issued by an institution, such as a government, utility or corporation. It's a way for these organizations to borrow money for operational purposes such as buying new equipment, paying off existing higher interest debt etc. The bond issuer agrees to pay fixed amounts of interest, called coupons, periodically (usually semi-annually) to the bond buyer and repay the amount borrowed on a specific future date. The face value of a bond is called “par value,” usually $100 when the bond is issued. The term of a bond can be from 1 to 30 years or longer. Canadian and U.S. bonds should be readily available from Canadian discount brokers.
Investors make money on bonds from the interest paid. They might also make a capital gain because bond prices fluctuate above and below par value, depending on current interest rates. Bond prices rise when interest rates go down because the marketplace prices existing bonds such that their total return is equivalent to the interest rate of new bonds. The converse also occurs: if interest rates go up, bond prices fall.
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