Before you start investing, it is imperative to understand every investor has different needs. For instance, a 24-year-old with a stellar job with no specific financial obligations may intend to invest a significant chunk of his income in long-term, high-growth instruments.
However, not everyone’s circumstances allow a high-risk appetite. For instance, an expecting mother could want a guaranteed corpus at the end of 15 years to fund her child’s higher education. This is where fixed-income securities can help.
Moreover, financial planning can meet your future needs like your child’s education, buying a house, retirement, etc. Requirements like these call for investment instruments that can offer fixed returns. Continue reading to learn more about fixed-income securities and what makes them a worthy investment option.
What Are Fixed Income Securities in India?
In simple terms, fixed-income securities are instruments that offer a fixed return on your investments. As an investor, when you make the investment you can come to know of the final payment receivable as well.
There are many types of fixed-income securities. Specific securities even provide periodic returns to create a steady income stream. Due to the fixed returns, many investors prefer these securities in their investment portfolio along with equity and other market-linked instruments.
Types of Fixed Income Securities
Many types of fixed-income investment options are available to Indian citizens. Let’s discuss the different types of fixed-income securities one can invest in:
1. Debt Mutual Funds
These funds pool investors’ resources to invest the corpus in various debt instruments such as bonds, T-bills, and other fixed-income securities.
Read More: Best Debt Mutual Funds to Invest in 2022
2. Treasury Bills
These are short-term fixed-income instruments issued by the government for 91, 182, or 364 days and do not carry any coupon (interest) payments. They are issued at a discount on their face value.
The face value is paid to the buyer on maturity. For example, a 91-day T-bill with a face value of Rs. 100 could be sold at Rs. 98.4. The gain of Rs. 1.6 is released on receiving the payment of Rs. 100 at maturity.
Bonds are fixed-income securities that are popular worldwide and offer predetermined returns. They are a standardised and fungible unit of a loan raised by a government or a company for a specific objective. The lenders are the investors who buy the bond, and the borrower is the company or the government issuing it.
4. National Savings Certificates
These are savings certificates you can buy from the nearest post office. They have a fixed maturity period of 5 years and a fixed interest rate. Apart from guaranteed returns, they also offer tax exemptions for investments up to Rs 1.5 lakhs under Section 80C of the Income Tax Act.
5. Money Market Instruments
These below-mentioned instruments comprise fixed-income securities with a maturity period of less than a year:
- Certificates of Deposit: A certificate of Deposit is a money market instrument issued by a bank that guarantees repayment of principal along with a pre-specified interest rate. This interest rate may be fixed or floating. A CD has a maturity period ranging from 7 days to one year. Available in only dematerialised form, CDs are governed by the RBI and have a minimum investment amount of Rs.5 lakhs.
- Commercial Paper: It is a fixed-income security issued by large corporations to meet short-term liquidity obligations. It is floated at a discount and redeemed at face value on maturity.
Examples of Fixed Income Securities
Let’s understand the working of a fixed-income tool with an example. Mahindra and Mahindra Financial Services Ltd.(M&M FS) launched bonds with a face value of Rs. 1000/- and maturity due in seven years. The coupon rate on the same was 8.53%. The company planned to repay its debt using the bond and generate enough profit in the coming years to repay the bond.
Therefore, if you bought ten bonds, you will be entitled to annual payments of 10 X 85.3= Rs. 853 till the bond’s maturity. These payments are your fixed- income for the next seven years. At maturity, M&M FS repays the bond of 10X1000 = Rs. 10000 to you along with the annual interest. In this period, you earned 7X853 = Rs. 5971/- as total interest
Why should you Invest in Fixed Income Securities?
As mentioned earlier, investors have different needs, risk appetites, and financial goals. Those looking for secure returns without tracking market fluctuations, irrespective of the earning potential, should invest in fixed-income securities.
In such cases, people creating a corpus for a child’s higher education or a family member’s wedding will be most inclined to take minimal risks with their investment. Fixed-income securities will be a suitable instrument for them.
Also, a person who requires a stable income can consider investing in fixed-income instruments. For instance, people nearing retirement must create a source of regular income even when they stop working. They can invest in different types of fixed income investment options that offer fixed payments at periodic intervals.
For investors with a higher risk appetite, fixed-income securities are an option to diversify their portfolios. To put it simply, including fixed-income securities in your portfolio can be helpful in balancing the risks associated with equity investments.
Risks of Investing in Fixed Income Securities
While fixed-income securities are a more secure investment choice, they are not entirely risk-free. Some of the risks of investing in fixed income securities are:
1. Default risk: Fixed income securities are ultimately an investment in debt or a portfolio of debts. They face the risk of the borrower defaulting on the loan.
One can manage this risk by investing in higher credit-rated securities. A credit rating is basically an assessment of a company’s financial history and its ability to repay borrowed debts.
2. Interest rate risk: Most of the time, fixed-income securities prices are inversely related to fluctuations in the interest rates of short-term government securities.
When the interest rates of these securities rise, the existing deposits become less attractive to investors who can earn higher coupons on the new securities.
As a result, their prices fall. Anyone aiming to sell their securities around this period will get a lower return than expected.
3. Inflation risk: Many fixed-income investment options are long-term securities with a fixed return. Consequently, persistent inflation could erode their actual recovery. On the other hand, market-linked securities automatically adjust as per the inflation rate in the economy.
4. Reinvestment Risk- This risk entails the possibility that you won’t be able to reinvest cash flows from a particular investment at a rate similar to the current return. Such a situation leads to an opportunity cost for the investor. Reinvestment risk is generally higher with securities with high coupon rates and long reinvestment periods.
The Benefits of Investing in Fixed Income Securities
These are the benefits of investing in fixed-income securities:
1. Consistent returns: Returns from fixed income securities are pre-determined. Thus, they offer consistent returns. Moreover, the risk of return fluctuations is minimal due to the lower variance than other instruments.
2. Relatively low risk: Since many of these securities are backed by the government, large banks, and corporates, they carry a relatively low risk. However, you should always do your due diligence and check the entity’s profile before investing.
3. Diversification of portfolio: As discussed earlier, it has been seen that there has been an inverse relationship between the returns from fixed income securities and other equity instruments.
Thus, adding fixed income securities to a portfolio balances its risk profile and makes it more weather-resistant.
4. Higher priority of being paid out in case of bankruptcy: In case the issuer goes bankrupt, the investors in fixed income securities get a priority in being paid back before the other stakeholders.
The senior secured debt holders get paid first, followed by other investors. The equity investors and promoters are the last parties to be paid.
It cannot be denied that we live in uncertain financial times. As we have seen, fixed-income securities offer a more guaranteed rate of return than many other popular investment choices. Hence, they are a prudent choice to add to your portfolio for assured all-weather durability.
The pandemic has proved how one region of the world can bring down economies in another region in a very short time. Thus, risk balancing of portfolios is needed today more than ever, and fixed income securities offer an excellent way of achieving the same.
What is the yield on fixed income securities? How is it different from yield to maturity?
The yield from fixed income securities is its annual income divided by the current price of such securities. Yield to maturity is the total expected return on securities if held to maturity upon reinvesting the periodic payments at a constant rate.
What happens to fixed-income securities when the stock market crashes?
Fixed income securities are considered a safer investment option. Their market price increases when the stock market falls. Very highly rated bonds and government securities remain a haven during prolonged stock market crashes. However, sub-investment grade bonds could increase the chances of default if the economy becomes recessionary.
What is the impact of inflation on fixed income securities?
If inflation rises during the tenure of a fixed-income security, it can negatively impact the returns that the security offers. For example, you have bought a bond that has a tenure of 5 years and a coupon rate of 5%. If the inflation in any year increases and becomes 8%, the effective return on the investment is -3%.
Can individual retail investors invest in Treasury Bills?
Retail investors can invest in T-bills by opening an account with the RBI Direct Scheme and investing a minimum of Rs. 10,000/-.
Are fixed income securities liquid?
Yes. Most fixed-income securities are highly liquid. Government bonds, treasury bills, debt funds, etc., are instruments with high liquidity. Instruments like FD, RD, etc., are available for use in an emergency. However, premature withdrawal reduces their returns on them.
What are floating rate securities, and how do they differ from fixed-rate securities?
Floating-rate securities have a variable coupon rate that depends on the benchmark rate like repo rate, MCLR rate, etc and thus changes basis any change in the benchmark rate. In the case of fixed-rate securities, the coupon rate is fixed at the time of issue and does not change during the tenure basis change in any external rates.