What is Fixed Income(Bonds)?

Key Points

• Fixed income is another term used to describe bonds and is considered to be one of the more secure investments one can make. 
• Bonds are debt instruments issued by companies to raise capital to fund projects and when purchased do not give you ownership in the company such as a common stockholder. 
• Allocating more of your assets towards fixed income makes sense as you age but for younger investors with higher risk tolerance, equity typically provides a better risk/reward proposition.

You Get to Play Bank by being the Lender and The Company Owes YOU

You are now a creditor to the company meaning you have lent money for a set period of time with agreed upon fixed interest payments. Almost all types of bonds depending on the structure of the issuance will pay you as the lender in cash interest payments on specific dates until its maturity.  

On a specified maturity date, the borrower (company) is obligated to return the full principal you originally invested which is usually $1K.

Much like a dividend yield, bond yields which represent your actual return also hold an inverse relationship with the price of the security (bond). 

The current yield reflects the constant changes in the bond’s price as opposed to its face value (the rate and price it was issued at).  

They are SAFE but That Usually Means Less Return

Historically, bonds have returned less for investors in comparison to other asset classes such as common stock. They are considered to be more secure due to the fact that within the payment structure or in the event of bankruptcy; bondholders have priority over common stockholders and preferred stockholders.

With this being said, bonds are rated by credit agencies (Moody’s) based upon a company’s Free Cash Flow (FCF) and whether their business model/financials look stable enough to pay off its debt issuance. 

Thus there can still technically be risk in holding a company’s debt if it has a low credit rating (junk bonds) and faces a liquidity crisis.

Bonds in a way can technically have unlimited downside with limited upside. The limited upside has to do with the fact that interest payments are issued at a fixed rate so if the company is doing very well the bondholder will not be further rewarded. 

This is why equity has historically been the superior investment product over the long-term when it comes to rewarding investors.