Fixed income investments
have a place in most individuals' investment portfolios. Bonds or other
types of fixed income investments provide diversification and predictable
income and are generally thought of as more conservative investments than
Deposit or Savings Certificates
Issued by banks, thrifts and credit unions, these instruments are probably
the easiest to buy and own. They are often available in maturities ranging
from 30 days to over five years. Since they are insured by the FDIC or
NCUA up to $250,000, the risk of default is almost nonexistent.
US Government bonds
The Federal Government also issues bonds of varying maturities. Treasury
bills are issued with maturities of less than a year. Treasury notes have
maturities from one to ten years and Treasury bonds have maturities from
ten to thirty years. US Treasury obligations are considered to be some
of the most financially sound investments available. Even though the risk
of default is negligible, the values of these bonds change as interest
rates change. When rates rise, values fall and vice versa. The longer
the maturity, the more their values will change with changing interest
Most obligations issued by states, cities and other non-federal governmental
bodies pay interest that is not subject to federal income tax. As such,
the interest rates on those bonds is usually lower than similar quality
and similar maturity taxable bonds. To determine if tax-free municipal
bonds are right for you, compare the after tax yield of a similar taxable
bond with the tax-free yield of a municipal bond.
Not all tax-free bonds
are of equal quality. Ratings agencies assign quality ratings to many
bond issues. They look at the credit worthiness of the issuer and other
factors. Usually it is a good idea to stay with high quality bonds - those
rated A, AA or AAA. The market values of municipal bonds also change with
changes in interest rates.
Corporations also borrow money by issuing bonds. The interest from these
bonds is fully subject to federal and state income taxes. The ratings
agencies also usually assign ratings to corporate bonds and staying with
the high quality bonds makes sense.
Ways of own bonds
You can buy individual bonds from many sources. Banks usually offer government
bonds and brokerage firms can sell all types of bonds. The biggest benefit
to owning individual bonds is the ability to choose exactly what bonds
you own. Most bonds send interest or you can have it deposited into your
With a fixed income mutual fund, you buy shares in a fund that owns a
portfolio of different bonds. The bonds are selected by the portfolio
manager who also monitors the bonds while they are in the fund. The portfolio
manager has the ability to buy and sell bonds from the portfolio as he
or she thinks the market is changing. For example, if the manager believes
that interest rates are going to rise, he or she may replace longer-term
bonds with shorter maturity bonds so there will be less price deterioration
if rates rise.
of bond mutual funds include the costs of the fund and being subject to
poor selections by the portfolio manager.
Unit investment trusts (or UITs) are like a mutual fund in that you buy
into a portfolio of bonds, but the portfolio remains static. Once the
UIT is formed, the bonds stay in place until they mature. Usually the
costs of a UIT are lower than a mutual fund but you give up the close
monitoring that is part of the portfolio manager's duties with a mutual
Words of Caution
You should also note
that the values of bonds, bond mutual funds and UITs change when interest
rates change. When rates go up, the values of bonds fall.
Fixed income investments
should be conservative tools used to lower overall portfolio risk and
to produce steady streams of income. There is often a temptation to consider
types of bonds or other fixed income investments that offer returns that
seem very high compared to the alternatives. Stay with high quality issues
bought from reputable institutions. When something seems too good to be
true, it often is.