Are you considering which securities you can add to your portfolio for retirement planning? There are several asset classes you can choose from. Some examples include equities, cash, fixed-income securities, real estate and futures.
Each asset class works differently in terms of risks and rewards. In this blog, we will discuss what are fixed-income securities and how you can invest in this asset class to generate income.
What Are Fixed-Income Securities?
Fixed-income securities are low-risk debt instruments. Governments and corporations issue them to raise funds and expand their operations. Investors can invest in these securities to:
- Generate income
- Balance portfolio risk that arises from stocks and other high-risk securities
These debt instruments allow investors to earn returns in the form of periodic, fixed interest payments. The fixed nature of these payments makes it easier to determine your total rate of return.
Investors also receive the principal amount invested when the security matures. For example, bonds are a type of fixed-income security. They can have a maturity of 30 days to 30 years (or more). Once the bond matures, the investor will receive the principal amount they invested.
3 Examples of Fixed-Income Securities
Now that you have a basic understanding of what are fixed-income securities let’s review some of the most common examples of fixed-income securities.
A bond is a type of loan or a financial obligation that an investor makes to an issuer. This is usually a government or corporate entity.
As mentioned earlier, these entities issue bonds as a way to raise money for a project or other operations. In return, the issuer makes a promise to repay the bond’s principal amount on a specific maturity date. The issuer will also make scheduled interest payments to the investor.
Australian government bonds are incredibly safe. If you buy these bonds and hold them, the government guarantees you will earn a return. There are 2 kinds of Australian government bonds available.
The first is exchange-traded treasury bonds. Investors trade these bonds on the ASX (Australian Securities Exchange). They pay a regular coupon interest and the principal amount at maturity. Investors can earn a fixed interest amount, paid every 6 months. They can also buy or sell these bonds on the ASX.
Besides this, you can also invest in exchange-traded treasury indexed bonds. The Australian government will pay regular coupon interest on these bonds until the bond matures. This is payable every 3 months. They will also pay the nominal value of the bond at maturity.
The government also offers inflation protection on exchange-traded treasury indexed bonds.
Besides this, you can invest in corporate bonds. These types of bonds are riskier than government bonds. If the company shuts down, you will no longer receive coupon payments. You may also not get your principal amount back.
Corporate bonds compensate for this risk by offering higher coupon payments compared to government bonds.
2. Treasury Notes
Treasury notes are a type of government-issued fixed-income security. They are short-term discount securities that investors can redeem on maturity.
The maturity date of these securities is less than 12 months. The Australian government issues these treasury notes to raise money for their short-term funding requirements.
3. Preferred Stock
We don’t usually consider stocks as fixed-income securities. They are more volatile than bonds and have a varying rate of return. However, preferred stocks function differently from common stock.
The company prioritizes preferred stockholders over common stockholders in terms of dividend payments. If a company were to go bankrupt, it would pay its preferred stockholders first (after paying its creditors).
Besides this, preferred stock also has a fixed dividend payment. You can use preferred stock as a fixed-income security and equity.
It functions as a fixed-income security because of its fixed dividends. It also offers capital appreciation in the same way as equities. If the price of the stock appreciates, investors can sell it to earn a profit.
Why Should You Invest in Fixed-Income Securities?
We discussed what are fixed-income securities and the different types of fixed-income securities available for Australians. Now let’s review some of the biggest reasons you should invest in this type of security for retirement planning.
You Can Earn Stable Returns
One of the biggest benefits of fixed-income securities is that you can receive a steady return on your investment for a specific period.
For example, suppose you invest in a fixed-rate bond with a maturity of 5 years and a 3% interest rate. In this case, you will earn a 3% return every year for 5 years. The interest rate won’t fall to 2.5% for any reason.
In comparison, variable-income securities are much more uncertain. You can earn a 7% return for one year and then zero returns for the next 2 years.
You Can Diversify Portfolio Risk
As mentioned earlier, fixed-income securities help diversify your portfolio risk. They carry lower risk than equities. This is because they are less sensitive to economic downturns, geopolitical events, and other macroeconomic risks.
You can allocate a portion of your portfolio to these securities and offset some of the losses resulting from stocks.
You can Preserve Your Capital
Another advantage offered by fixed-income securities is that they allow you to protect the original value of your investment while earning steady returns. When you are approaching retirement, you can also sell these assets to generate income.
These assets are a good choice for investors who have a shorter investment horizon and cannot recover from heavy losses.
Wrapping It Up
We hope this article proved useful for understanding what are fixed-income securities. If you want to learn more about Australian government bonds, visit https://www.australiangovernmentbonds.gov.au/. You can find out how you can start investing in these bonds.
We also recommend consulting a financial advisor for advice on retirement planning. Please follow Life Boss for more interesting articles on money and personal finance.
Disclaimer: All investments involve risk. The content of this blog is not financial promotion or investment advice. It is general information for reading purposes only. Please speak to a financial advisor before investing.