What is Fixed-Income Investment

Fixed-income investments give the investors a predetermined return. Examples are Certificate of Deposit, treasury bills, bonds, and so on. The interest rate is fixed, so the return is often known. Unlike equity investment, investors can’t foresee the price movement of the equities and their returns. Fixed-income investment can add more stability to one’s portfolio. If you are about to retire or needing constant cash flow, having fixed-income investments is a better choice because, in the short term, returns of equities can change a lot.

What is Fixed-Income Fund

Fixed-income funds are mutual funds that invest in bonds, high dividend equities, or a mixture of both. It is a fund that consists of many fixed-income investments and provides investors a regular payout. The underlying assets are usually from the government or corporations. They’re popular among investors who want to diversify their portfolios and limit risk by investing in a range of interest rates generating assets. The fund’s managers decide which securities the fund buys and when it sells them. Fund managers manage Fixed-income funds, so the expense ratio is usually high. But they design the fund in a way to maximize return and control the risks. It usually generates a higher payout than if you buy a certificate of deposits or bonds yourself.

Three Types of Fixed Income Funds

Type 1: pure bond

The first type is the fixed-income fund that consists of bonds. To generate income for its shareholders, a fixed-income fund will lend money at one interest rate to borrowers who need loans. This lending is done in the form of purchasing a bond issued by the borrower. For example, suppose a company needs to borrow money to expand its business. In that case, it issues a bond with a face value of $1000 and a yearly coupon payment of $40 to its lender until the end of the borrowing duration. The coupon rate is $40/$1000=4%. The bond can be one year, five years, or ten years. The price of the bond is not fixed though. If the interest rate moves, it will affect the bond price. The current bond price is calculated based on the interest rate (discount factor) and how far the bond is to its maturity. In general, the higher the interest rate, the lower the bond value is, given everything else the same, vice versa. To understand this concept fully, you need to understand the concept of the time value of money. Essentially it means $100 today is more valuable than $100 in the future. suppose the interest rate is 1%. $100 today is the same value as $101 a year later. Time is an essential factor in deciding the value of money.

If you look at fixed-income funds, the price movement is much less than equities because interest rate movement is relatively milder than equity price itself.

One example of this type of investment is Vanguard Short-Term Corporate Bond ETF. The price movement is slight, and it provides a fixed monthly payout of $1.0.

One can also buy and sell bonds in the market to speculate on the interest rate change. The interest payout is usually fixed based on the terms and conditions of the bond. Therefore it provides investors a so-called fixed income. If the fund consists of many different bonds and is structured to provide a monthly payout, investors can receive passive income by investing in this fund. The price movement of the fund is less volatile than the equity fund.

Type 2: pure equity

The second most straightforward method to buy a passive income for life is through high dividends paying investment. Dividends are payments made from the profit generated by companies’ stocks/shares to their shareholders once a year. Dividends can be paid in cash, stock, or other securities to shareholders and are most often distributed quarterly. Most companies pay dividends regularly. Especially the high dividend payment companies that have a solid track record of paying dividends tend to be the ideal candidates for a fixed-income investment. If a fund consists of hundreds and thousands of high dividend-paying equities, the fund’s investor will receive recurring passive income. One example of such investment is Fidelity® Equity Dividend Income Fund. This fund pays out dividends four times a year, and the fund price is appreciated in the last years.

Apart from that, investors can also benefit from the price appreciation of the shares.

In contrast to the bond type of fixed-income fund, this fund has more significant price movement, more volatile. If you plan to cash out in the short term, you need to consider that and have a well-thought exit strategy. Because maybe the day you decide to sell, the price of the fund drops a lot. Then you lose your initial investment.

Type 3: mixed

The third type of fixed-income fund consists of both equities and bonds. It combines the growth potential of equities and less volatility of the bonds. It is less risky than a pure equity fund and riskier than a pure bond fund. But it can generate a good performance while keeping the risk level reasonable for more reserved investors. One example of such investment is Alliance Income and Growth Fund. It has around one-third of equities and one-third of bonds. For each share, investors receive a $0.06 monthly payout. The share price movement is minimal compared to type 2 funds.

How to ‘buy’ passive income for life

To make the example more straightforward, I will use the example in the Type 3 fixed-income fund. The current price of the Alliance Income and Growth fund is $10.33, and it moves up and down, but stays in that range. Let’s say you use the dollar-cost averaging method and invest $1000 each month in this fund. The average price is $10. You would have $6 more passive income each month.

In a year, you will have a $72 monthly passive income. Imagine you set up automatic buy and do it for ten years. You would have a $720 monthly passive income for life, as long as this fund still exists.

You can supercharge it with a leveraged investment and may even double the amount. But this involves high risk, and you should know what you are doing and control the risk.

Each $10 you spend unnecessarily costs you $0.06 forever passive income. If you get a parking ticket fine of $250, hey, it is $1.5 cost to you every month forever. On the other hand, if you cut unnecessary expenses and put this money into a fixed-income investment, your quality of life does not change, but you buy yourself a passive income for life.

If you manage to have more disposable income and want to prepare for early retirement, you can buy a fixed-income fund over time, and in 15 years, you might buy yourself freedom from a 9-5 job!

Disclaimer: This article not financial advice. It is for explanation purposes only.