Fixed income: A quick discussion
If the volatility of the stock market makes you reach for the Pepto Bismol and you’ve decided that capital preservation is for you, then you’ve come to the right place. There are various instruments under this category and we’ll discuss some of these presently. Fixed income usually is in the form of Cd’s or bonds. In both cases you are lending money to a specific entity, with the promise that you’ll get paid back in full at a specific date in time.Yearly interest payments are made to you in the interim. The key to understanding bonds is that during the course of the time that you hold them, they will fluctuate in value depending on the current interest rate. In general, unless you trade bonds or are forced to sell one, you will not have to worry about values. When the bond matures you will get the face value of your investment back. Consequently when you buy a bond you may have to pay more or less of the face value of the bond, depending on the current interest rate. For example, a $10K bond giving 5% may cost you more if the current new bonds being offered are only 4%. Obviously 5% is better than 4%. So for this privilege you’ll pay a premium. On the other hand if you want to buy a 4% bond in a market that is offering 5% bonds, then a 10K bond may only cost you 9.5K. In either case checking with your broker or brokerage house and discussing strategies with them is advised. The following are various fixed income investments that are the most popular:
CD’S- loans made to banks. Keep investments under 95K to take advantage of the FDIC Insurance in case of bank insolvency.
Treasury bonds – Money lent to the government. The safest of all bonds. Backed by the government. They are federally taxable, but state tax exempt.
Municipal bonds – money lent to the states. Very safe if AAA rated and insured. Relatively expensive as bonds go. Federally tax free and state tax free if the bond is that of the state you live in. Exceptions to this are US territories and Puerto Rico bonds which are state tax free everywhere.
Corporate bonds – money lent to corporations. Fairly safe if AAA rate. No tax advantages, but have good interest rates.
Agencies and GinnieMaes – Federal bonds that deal with real estate. Agencies if AAA are very safe, relatively inexpensive, have good interest rates and some may be state tax exempt. They are all federally taxable.
Bond Mutual funds – mutual funds that invest in any of the above bonds. Good for people who don’t have large amounts of capital to invest and like liquidity. More prone to interest rate fluctuations than the actual bonds themselves. This is a good vehicle if you like risky bonds. You can have an entire basket of what is known as junk bonds with less risk than you would have if individually held. This can increase your interest earnings.
Whatever way you choose, either through individual bonds or mutual funds, fixed income opportunities abound and what you choose will be up to your particular specifications.
