Fixed Income Investments

Investors have two types of securities to choose from: equity securities and debt securities. Equity securities are usually stocks or shares of a publicly held company. The investor actually becomes an owner or shareholder of a part of the company issuing the shares, referred to as common stock. Equity investors buy stocks with the hope that the company issuing the stock will prosper over time, thus increasing the value of the stock. Equity investors also take on greater risks because their fortunes are tied to the company they invested in. These investors assume the greater risk to get the greater rewards that stocks can yield on a very long term basis.

With debt investments, also known as fixed income investments, the investors are actually lending their money out to a company or government agency for an interest rate and time period specificied in the investment agreement usually called a bond. Most bond issuers will pay the interest to the bond holder every 3 or 6 months. When the bond matures, the issuer pays the principal back to the bond holder. Some companies will also issue a preferred stock, which is set up to pay a certain dividend amount, usually every 3 months. Many investors and investment brokers consider this a fixed income investment since it does pay a pre-established (fixed) dividend amount.

The US government is one of the largest issuers of fixed income investments in the world. The treasury department issues 3 kinds of fixed income investments. Treasury bills are issued for a maturity period of 7 days up to one year. Treasury notes are issued with a maturity date between 1 year and 10 years. Any treasury debt investments with a maturity date over 10 years is called a treasury bond. These investments are not the same as savings bonds. These are sold at a discount to the face value. For example, a $500.00 savings bond would sell for $375.00. On the maturity date the savings bond holder gets the face value of the bond. Even if the savings bond owner redeems the bond before its maturity date, they are guaranteed to get their principal back along with interest to date less a small penalty for the early redemption.

This difference points out the major risk of fixed income investments, Interest rate risk. When interest rates go up, the value of fixed income securities can go down. If a bond has a 6% interest rate and interest rates go up to 8%, the value of the 6% investments would decrease by 25% if the owner wanted to sell it before it matures. Investors always seek the best return possible, so they buy the 8% investments, not the 6% ones. If the owner of a 6% investment direly needed to redeem the investment they would only be able to get $750.00 for it. $60.00 annual interest on a $750.00 bond is 8%, the prevailing interest rate. Therefore, fixed income investors need to make certain to have more liquid funds available for emergencies so they will not have to redeem their fixed income investments at a loss.

The rewards of fixed income securities offset the interest rate risk. Bonds have a guaranteed interest payment for the life of the bond as well as guaranteed principal payment at maturity. Since bonds are debts and not an ownership interest, if the issuer were to go bankrupt, bond holders will have their principal repaid before the shareholders do. Many fixed income investors prefer the US treasury bills,notes and bonds because they are backed by the full faith and credit of the US government.