In today's dynamic and volatile economic landscape, interest rates have witnessed a significant spike, presenting new challenges and opportunities for investors. As interest rates rise, Fixed Income products have become a focal point for financiers seeking stable and reliable income streams. Before delving into Fixed Income products, let’s understand their denomination and recognise their functions. Fixed Income products play a crucial role in diversifying portfolios and mitigating risks associated with higher interest rates, such as asset devaluation; offering capital preservation. They provide a predictable stream of income over a specified time period, which is also greatly beneficial for future financial planning. These products include bonds, certificates of deposit (CDs), treasury bills, and other debt instruments issued by governments, corporations, and financial institutions.
Also known as the backbones of fixed income, bonds are widely recognised as the core component of fixed-income investing. They are debt instruments issued by the government or corporations in order to raise capital. In a high-interest rate scenario, newly issued bonds tend to offer higher yields to attract investors, especially since interest rates and bond prices are inversely related. Consequently, bond-holders can enjoy increased income generation.
For new investors, investing in bonds can get confusing, since there are multiple varieties, types, and categories. Here are different types of bonds you can consider investing in.
These treasury bonds are considered relatively low-risk due to the backing of the government and help in supporting government spending and obligations. They are long-term investment tools, with the investment period ranging from 5 to 40 years. Although they provide a steady flow of income, due to their low risk, government bonds typically pay low-interest rates.
On the other hand, Corporate Bonds may offer higher yields to compensate for their higher credit risk. If you can park your money for 2-3 years, they offer betterreturns than Bank Fixed Deposits of similar durations. However, investors must carefully analyse the creditworthiness of issuers to assess the risk-reward trade-off.
Also known as adjustable-rate bonds, these bonds are a type of government bond that can provide a hedge against rising interest rates; acting as a shield. These bonds have a variable interest rate that adjusts periodically, typically based on a reference rate like LIBOr (London Interbank Offered Rate) or the prime rate. Further, it is especially advantageous to buy Floating Rate Bonds when you expect market interest rates to rise. When interest rates increase, the coupon payments on floating-rate bonds rise in tandem, protecting investors from the erosion of fixed-income value.
Inflation Linked Bonds are linked to the Consumer Price Index, with principal and interest payments being adjusted for inflation. As they protect the purchasing power of the investor’s capital, Inflation Linked Bonds are a popular option for investors seeking to protect their wealth against the adverse impacts of inflation.
Commonly known as ‘munis’, they are issued by state and local governments to finance public infrastructure projects. These bonds offer tax advantages, as the interest income earned is typically exempt from income taxes, and provide an alternative option to traditional financing. In a high-interest rate environment, tax-advantaged municipal bonds can provide an attractive after-tax yield, making them appealing to investors seeking tax-efficient income.
If you’re confused about which Fixed Income products to invest in, Debt Mutual Funds give investors a chance to invest in a variety of debt instruments. Also known as Bonds Funds, they pool investors' money to invest in a diversified portfolio, reducing the risk associated with investing in a single bond. These funds can be actively managed or passively tracked through a bond index. Additionally,professional fund managers actively adjust the portfolio's duration and credit quality to optimise performance in varying interest rate environments.
Besides Bonds, other Fixed Income products you can invest in include Certificates of Deposits and National Savings Certificates.
These are time deposits offered by banks and credit unions with fixed interest rates and maturity dates. CDs provide a secure investment option for risk-averse investors seeking stability and regular income. In a high-interest rate environment, investors can take advantage of rising yields on CDs, thereby securing a predictable income stream. As inflationary pressures mount, investors seek protection against the erosion of purchasing power.
Saving certificates are great for conserving income from tax, gaining tax exemptions for investments up to Rs. 1.5 lakhs under Section 80C of the Income Tax Act. The savings bonds have a fixed maturity period of 5 years and fixed interest rate and are issued by the India Post.
Benefits of investing in NSC include a low minimum investment of Rs. 1000 only, guaranteed returns with near zero risk of default since its a government scheme, accessibility all over the country, and can be used as collateral for loans from banks and NBFCs (non-banking financial institutions).
Treasury Bills are promissory notes issued by the government, with a guaranteed repayment at a later date. There are various kinds of treasury bills, such as 14-day, 91-day, 182-day, and 364-day treasury bills, which require a minimum investment that is risk-free with non-competitive bidding.
In a high-interest rate scenario, Fixed Income products become essential tools for investors seeking stability, income generation, and risk mitigation. Bonds, floating rate bonds, CDs, TIPS, municipal bonds, and bond funds offer distinct advantages depending on investors' risk appetite and investment objectives. Understanding the characteristics,risks, and potential rewards of these Fixed Income products is crucial for navigating the dynamic landscape of a rising interest rate environment. Investors should carefully assess their individual financial goals, risk tolerance, and consult with financial advisors to build a well-diversified fixed income portfolio tailored to their needs.