The fixed income investment market represents the safest investment opportunity in all of the financial markets. Fixed income instruments trade in the debt capital markets, and returns from these investments typically are not as promising as other asset classes, such as equities. Bonds, which are forms of debt, are issued by companies in addition to local and regional governments that pay investors ongoing interest payments, or a fixed income. Although bonds are the most dependable of investments, there is risk, and some fixed income investments are safer than others.
Every investor has a risk-and-reward profile. This represents the amount of risk he or she is willing to take on in search of a particular type of return, such as double-digit percentage returns over the course of one year. Based on that profile, you can determine if a fixed income investment is right for you.
Bonds are issued by a company that is in need of funding for some project, such as an expansion. The investor becomes a lender to the company, which becomes the borrower. A company must be disciplined to retain enough of its earnings or profits to maintain cash principal payments to investors over the life of the bond and to repay the face value of the fixed income investment when the contract expires. Regional governments often use proceeds from bond sales to pay down a national debt, and a local or state government might issue bonds for budgeting needs.
A government bond is among the safest fixed income investment. The length of these investment contracts vary and can last anywhere from three months to 30 years. Returns are not as robust as with riskier bonds, but you can expect that principal payments will be made for the duration of an investment contract. In order for a government bond to default, an entire region or state would have to default on its debt, and in major economies, that is unlikely to occur.
The riskiest of all fixed income investments are distressed debt or high-yield bonds. Although returns from these securities are higher than a government security, distressed debt investments are more at risk of defaulting. Often, these companies are in bankruptcy or are close to filing for bankruptcy. If a distressed company emerges from bankruptcy, the potential for investor rewards can be great. Otherwise, investors can lose everything.
You might also prefer a fixed income fund. A bond mutual fund makes investments primarily across the fixed income market. By selecting a bond fund as a fixed income investment, you gain access to multiple bond securities with different risk exposure, including government and corporate bonds.
One way to choose the best fixed income investment is to obtain research and ratings as provided by third-party rating agencies and financial analysts. It is the job function of a ratings agency to assess the likelihood that a bond issuer will make good on its payments to lenders and the chances for default. Based on this rating, you can decide whether or not the risk and reward potential are appropriate.