Are Fixed Income Securities good options to diversify one’s investments?
A lot of customers investing in Direct Plans of Mutual Funds on Finity ask us something along the lines of:
- What are Fixed Income Securities?
- What are different types of Fixed Income Securities?
- Are Fixed Income Securities something that an investor should consider when diversifying their investments?
So, today I decided to talk about Fixed Income Securities in detail.
But before I start, let me tell you a real-life story:
Last week, I celebrated the birthday of my four-year-old nephew. His grandpa had gifted him Rs. 1000. He might have no idea what to do with this money, but he is very smart. He handed over Rs. 1000 to his mother and told her that he will take this money back on his next birthday. But that’s not it! There’s some fine print as well. He gave this money to his mother on one condition that, she will get him his favourite chocolate every month. Hats off kiddo!
Having majored in finance, I realized that my nephew just sold her a fixed income security.
What is fixed income security?
A fixed income security is a type of investment that gives some fixed returns in the form of
periodic payments as well as on maturity, you get your principal amount back. In this
mode of investment, the investor knows the amount of periodic payments he will be
receiving. It is fixed in advance, even before the investor hands over his money to the issuer. Tell me, can it get any safer than this?
Types of fixed income security: Fixed Maturity Plan, Fixed Deposits, Public Provident Funds (PPFs), Treasury Bills, Bonds, National Savings Certificate (NSC), Post Office Monthly Income Scheme (POMIS) etc.
Advantages of investing in fixed income
- No need to constantly monitor your fixed-income investments all the time.
- The most important reason for investing in fixed income security is that your principal amount will be safe along with a steady source of income. Worried about next recession? Not any more. Worried about retirement? You shouldn’t be.
- And not just this, you get to diversify your portfolio. Worried about market volatility? I’m not, are you?
Disadvantages of investing in fixed income
All of the advantages mentioned above come with a cost. Here are some disadvantages or risks in fixed income:
- The rate of interest for fixed income securities is comparatively lesser than other financial instruments.
- Interest rate risk i.e. price of fixed income security decreases when interest rate increases. As a matter of fact, usually, the interest rate for short term investment is lesser than that of long term investments. So, it is not a good option if you are looking for quick money.
- Sometimes the issuing company doesn’t perform well and is unable to pay back your principal amount. This is called Credit Risk. So it is very important to do a thorough analysis of company to ensure that you don’t become a victim of Credit Risk.
Current scenario and outlook
RBI has increased the repo rate to 6.50%, to keep the inflation under control. Due to rise
in interest rates, the price of the fixed income security got decreased (which was previously issued at a lesser rate). This, in turn, reduces the returns of the investor. But it’s a positive sign for investors
planning to invest now, as the rise in interest rate can be seen (which is ranging from 6.5 percent to 7.5 percent in recent times).
Investments in fixed income securities are an important part of personal investment portfolios and will always be (even if interest rates go up). Many asset classes give unpredictable returns, unlike fixed income securities. More importantly, as an old saying goes, one must never put all his eggs in the same basket. Along with investing in Direct Plans of Mutual Funds, it is important to have some amount of corpus in fixed income securities depending on your expectations on returns, your personal risk appetite as well as your time horizon of investment. I would like to end this post with some food for thought for you:
Future of fixed income is anything but fixed.