What Are Fixed Income Investments, And How They Fit Into Your Portfolio

For investors who want to take on less risk with more modest returns, fixed income investments (also known as bonds) could be what you’re looking for. Here’s how they fit into your portfolio. 

In today’s world of meme stocks, high-valuation technology stocks and volatility in the cryptocurrency market, supernormal returns seem to be, well… the norm that new investors strive to achieve. However, it’s not every day that the man on the street can multiply their portfolio value by tenfold — at least, not without a heightened degree of risk. 

For the risk averse, fret not — there are still plenty of investment options for you to choose from, be it the steadier blue chip stocks, well-diversified, index-tracking exchange traded funds (ETFs) or fixed income investments.

This article will break down all you need to know about investing in fixed-income products.

• What are fixed income investments?
• Why invest in fixed income?
• What are the risks involved when investing in fixed income?
• Types of fixed income investments in Singapore
• How much of your portfolio should you allocate to fixed income?

What are fixed income investments?

Fixed income investments, also known as bonds and often used interchangeably, are a low-risk investment asset class. 

They are a type of debt instrument that can be issued by governments and companies. These entities borrow investors’ money and pay interest in return, so that they have the capital required for purposes such as expansion and growth. 

When you invest in a bond, you invest a fixed lump sum of money in return for regular coupon payouts over a predetermined period of time. The interest returns you receive for these coupon payouts are typically fixed even before you apply. At bond maturity, you will also get back your principal. 

Here’s a simplified example of what a bond might look like: 

• Interest rate (Coupon payout): 3% p.a., given out semi-annually 
• Maturity date: 10 years
• Minimum investment amount: S$1,000

So if you were to invest S$10,000 in the bond above, you’ll receive S$300 per year for 10 years before finally receiving your capital of S$10,000 at bond maturity. This would total S$13,000 in interest and capital. 

Why invest in fixed-income products? 

#1 Stable asset class

Fixed income investments come with expected payouts. This gives you some visibility into the returns that you will receive in the coming months or years. Compared to other classes that fluctuate depending on the market conditions, fixed-income products provide that layer of stability to an investment portfolio. 

#2 Diversification of portfolio 

Besides providing stability to a portfolio, fixed-income products also help investors to diversify their portfolio. This means spreading your eggs across multiple different baskets, helping to balance out the volatility of asset classes such as stocks and commodities. 

#3 Preserve investment capital 

Having understood the concept of bonds, you’ll see that bonds are one way to help you preserve your starting capital. Coupon payouts aside, you’ll receive your principal amount at the end of the tenure. This is especially so for bonds that are backed by the government, such as the Singapore Savings Bonds. 

There is just one caveat — there are higher risk bonds around that could end up with the company defaulting on the bond. 

#4 Steady stream of income 

By giving coupon payouts in regular tenures, this gives you, the bond-holder, a consistent stream of income. This is similar to how annuity plans work. 

What are the risks of investing in fixed-income products?

As safe as fixed income might sound, like all other investment products, it comes with its own set of risks. 

#1 Risk of default 

The biggest risk of fixed-income products is the issuing party defaulting on the bond. When a company defaults on a bond, not only will you fail to receive the coupon payouts, you could also lose your investment capital. 

This is why it’s important to check the credit rating of the bond. The better the bond issuer’s credit rating, the lower the risk of default as the rating reflects the issuer’s creditworthiness. For example, on the S&P Global Ratings scale, the highest grade is AAA, followed by AA and A — all of which are investment grade ratings. 

If you’re risk-averse, you should opt for bonds with investment grade credit ratings, or bonds that are backed by the government.

#2 Low rate of return compared to other investment types

Fixed-income products typically offer low returns. This means that they face inflation risk — the risk of having your capital eroded (outpaced) by inflation. 

As such, you could be better off putting the money into products that offer higher returns, with higher liquidity. Examples of such products include cash management accounts and the lower risk portfolios offered by robo-advisors. 

#3 Low liquidity

Bonds come with a maturity period. This means as a bond-holder, you’ll have to hold onto the bond for the stipulated number of years in order to receive the full coupon payouts and your principal capital at the end of the tenure. In essence, your money is locked up for those years. There are a few exceptions, such as the SSB, that allow you to withdraw your capital anytime. 

There is another way out: sell it on the stock exchange. However, these bonds listed on the exchange can have low liquidity. This means that there could be little demand for the bonds. Without a willing buyer, you’ll be unable to sell off your bond on the market. 

#4 Interest rate risk 

When interest rates rise, the market price of existing bonds tend to fall in tandem as new bonds with higher returns are introduced and you face higher opportunity costs of holding onto your bond. However, this is a risk you’re exposed to only if you have plans to sell the bond before the maturity date.

This is also why in a low interest rate environment, it’s going to be difficult to find bonds that pay out a high yield. For example, for the later half of 2020 and early 2021, new SSB issuances had average returns of less than 1% p.a.