While the public is more likely to hear about the ups and downs of the stock market on the news, there’s another market where companies (and governments) fund themselves and people buy and sell the securities as investments: the global bond market, worth some $128.3 trillion as of August 2020.
The global bond market is the cornerstone of the larger world of fixed-income securities, a vital pool of investments that are an important part of any individual or institution’s plan for savings and investments.
What are Fixed Income Securities?
To understand fixed-income securities and investing in fixed-income securities, it’s important to understand what “fixed income” means, and how that designation sets these securities apart from other investments that can be bought and sold.
“Fixed income” refers to the structure of the security itself: fixed-income securities like bonds return a preset payment that legally can not change, known as the interest, and also the principal, which is returned at a set time in the future, known as “maturity.”
How Fixed-income Securities Differ from Other Securities
The interest on a bond is predetermined and can never change, regardless of market fluctuations. Typically these interest payments are protected by law, meaning that if a company that can no longer make payments, it risks being taken over by its bondholders (ending up in bankruptcy).
This extra layer of protection means that bonds and other fixed income securities are thought of by investors as something that can generate income (the payments) and some gain in overall value, but do not typically have the same potential for price appreciation as stocks.
In contrast, consider companies that pay dividends on their stocks. Those companies are able to increase, decrease, or even cancel the payments at their discretion.
Utilizing Bonds as a Fixed Income Security
The heavy hitter in the fixed-income world is bonds. Bonds are basically investments in the debt of a federal or local government or a corporation, or sometimes debts like mortgages or auto loans.
Think of bonds vs stocks like this: Because of their predictable yield, bonds are generally more low-risk than stocks, which have a value that can fluctuate minute to minute.
There are a few different types of bonds, each of which have their own unique attributes. It’s also worth noting that some bonds can be “callable”—meaning, the issuer can choose to repay investors the face value of the bond before the maturity date arrives. In those cases, interest is not always guaranteed.
Corporate bonds
There’s almost $41 trillion worth of corporate bonds outstanding that run the gamut from very safe, low-yield bonds issued by huge companies to the riskier, higher-yield bonds issues by companies whose prospects for future earnings are more uncertain.
High-yield bonds used to be called “junk bonds”. These are bonds issued to fund companies that often don’t have long track records of steady profits or have fallen on tough times recently and thus have to pay more for the privilege of borrowing money. While these bonds are considerably more risky than the so-called “blue chip” market, they also provide more opportunities for profits, both because their value tends to sway and that they have higher coupon payments.
Typically the easiest way for an individual or retail investor to invest in corporate bonds is to use an investment product like an exchange-traded fund, what’s known as a “fixed income” or bond ETF, specifically for bonds.
Government bonds
While the corporate bond market is almost unfathomably big, it’s actually the smaller portion of the world of bonds. About two-thirds of the overall bond market, or almost $90 trillion, comes from governments or public agencies that issue debt to fund their activities, and pay it off with either tax payments or a stream of fees that governments have special access to.
Whenever you hear about the “national debt” or deficit of a country, you’re hearing about a set of outstanding bonds that a country uses to cover the gap between taxes and spending. The biggest player in government debt is the United States, which has over $27 trillion in outstanding debt, $20 trillion of which is “held by the public,” meaning actual bonds and other securities that individuals and institutions own.
There’s also debt issued by states and local governments, some of which offers tax advantages for investors, and debt issued by government-affiliated agencies, like Fannie Mae and Freddie Mac, the two housing finance corporations.
Debt issued by the federal government tends to have the lowest possible yield of any debt for its duration (meaning the time during which an investor gets the coupon payments), because it’s assumed by the market to be risk-free. (Think government savings bonds.) This is why corporations or institutional investors with a large amount of cash will sometimes buy government debt in order to earn something back but not risk their overall investment, compared to keeping it in cash.
Other Types of Fixed-Income Securities
While bonds are the heavy-hitters of the fixed-income securities world, they’re not the only ones. Some fixed-income securities are more like stocks, while others more closely resemble bank accounts, and can even be purchased through your bank.
Preferred stocks
Preferred stock has a fixed payout like a bond and is given a “preference” over common stock, meaning that before dividends are paid to common stockholders, they need to be paid to preferred stockholders. Preferred stockholders are also prioritized when a company liquidates or goes out of business—the “senior debt,” aka bondholders, get paid out first, then the preferred stockholders, and finally the common stockholders get paid last.
Money market funds
Money market mutual funds are similar to checking accounts, in that people can invest in them and the value is supposed to stay stable. These accounts typically invest in short-term debt investments that provide low yield but are low-risk as well. They can be used in a similar way to checking accounts but do not have the type of Federal Deposit Insurance Corporation (FDIC) insurance that bank products will have.
One way to think of a money market mutual fund is as a fixed income investment product that you can always sell out of and into at a stable price.
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Certificates of Deposit (CDs)
One of the most well-known types of fixed income security, Certificates of deposit (CDs) may not seem like a “security” at all and are typically purchased through a bank, not a broker.
Unlike a bank account, however, CDs cannot be accessed for a set amount of time, which makes them more similar to traditional fixed-income investments. Likewise, with a CD an investor gets a contractually obligated stream of payments that is predetermined when they purchase the security.
One unusual aspect of CDs is that they’re insured by the FDIC for up to $250,000, making a CD as close to a risk-free investment as there is in the fixed-income world, next to federal government securities. The low risk, however, tends to come with correspondingly low interest rates, making CDs a savings product more than an investment one.
The Takeaway
Fixed-income securities like bonds, preferred stocks, money market accounts, and CDs offer steady payments and little to no income fluctuation. But with that low level of risk comes a generally low level of payoff. For investors who like knowing exactly what they’re getting, fixed-income securities can be an asset to a portfolio.
SoFi Invest® can help you build a customized portfolio that includes-fixed income securities, including fixed income ETFs. SoFi Invest requires as little as $1 to start saving and investing today.
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