The best portfolio has a mix of high-risk and low-risk assets. Equities fall in the first category, while fixed-income assets like bonds fall in the low-risk category. Having a small proportion of these low-risk instruments can help improve the portfolio’s overall risk.
Before you can do so, it is
1. What is the fixed income market: The fixed income market is one of the biggest segments of the international financial system. It is nearly twice as big as the entire stock market, and this is what makes it so very
2. What are bonds: Companies and governments issue bonds when they have to borrow money from the public. This is often considered a cheaper source of borrowing; it is more cost-effective and faster than obtaining bank loans. Such bonds are often issued to help raise funds for development work. When you invest in a bond, it assures you a fixed interest payment every year for a certain period of time. The interest payment is often called ‘coupon’ and the time period is called ‘maturity period’. By the end of this period, the principal amount you invested is returned. This is why it is called a fixed-income security – you know exactly how much and when you earn back your money.
3. How it works: Bonds in the fixed income market are very much like a stock Initial Public Offering (IPO) issued by a company. Within the market, groups looking to raise funds tie up with investment banks. They determine the right coupon or interest rates, the time period of the bond and how much money they want to raise. After this, the bonds are sold to large-scale investors by these investment banks. Initially, just like an IPO, investors have to bid for these bonds. Once the bonds have been allotted, they can be traded on the market just like shares.
4. Other securities: Bonds are not the only fixed income securities. There are other instruments like Certificates of Deposits (CDs), money-market funds and so on. Even bank and corporate deposits can be considered a kind of fixed income instrument.
5. Tax Status: Most corporate bonds are taxable investments. However, some kinds of bonds are tax-exempt too. That means the income or profits associated with these bonds can’t be subjected to taxation. The interest on these bonds is lower than taxable bonds, since investor doesn’t have to pay any tax on interest returns.
6. Credit risks: Bonds and other fixed-income securities are often considered low-risk assets. Government bonds are considered risk-free securities. However, some bonds have higher risk. This is dependent on the inherent ability of the bond issuer to make the payments. This is called credit risk. Even now and then, bond issuers are rated by agencies for their credit risk. A lower credit rating means the bond is more risky. It affects the bond’s price and interest rates.
7. Retail investors: Bond markets are not easily accessible to retail investments. Some bonds have a high minimum investment value. This is why the best way to invest in bonds is through a fixed-income mutual fund scheme. However, tax rates of fixed-income funds are different from equity funds. These funds need to be held for a minimum of three years. Otherwise, they will attract short-term capital gains tax. This is the same as your income tax rate.