Fixed Income Securities are those instruments which make it possible to generate steady income for the investors, through payments in the form of interest. Generally, they are less in risk, compared to stocks, and their returns are predictable.
Therefore, they always play an important role in an investor’s basket. In this article, we shall delve into four chief types of fixed-income securities-bonds, fixed deposits (FDs), public provident funds (PPF), and bond exchange-traded funds (ETFs). All of these have different specialties and advantages. So, let’s discuss them and analyze how to make the right decision for your investment objectives.
Bonds: Lending Money to Institutions
What Are Bonds?
A bond is a loan you make to an institution. An institution in this case, the government or a corporation in exchange for regular interest payments and the return of your principal amount at the end of the term, or maturity, of the bond. Bonds are generally classified according to their issuer:
Government Bonds: These are issued by the government and are often considered to be low-risk investments.
Corporate Bonds: These bonds are issued by corporations and have higher yields but normally entail a little more risk than the government bonds.
Advantages and Disadvantages of Bonds
Advantages: Bonds have a predictable income flow or stream. Government bonds, of course, involve lesser risks. This makes them ideal for risk-averse investors. Corporate bonds can bring greater returns that even out the increased risk.
Cons: The interest paid affects bonds. Generally, an increase in the rate of interest lowers the price of a bond, while a decrease increases it. Furthermore, corporate bonds have credit risk which is the risk from credit failure meaning that should the company issuing a bond fail to pay, you will lose at least part of your invested capital.
Who Should Invest in Bonds?
If you are a conservative investor, looking for stable returns, then bonds may be an ideal choice, especially when the stock market displays periods of fluctuating results. The same applies in diversifying a portfolio that has a high investment in equities.
Fixed Deposits: The Classic Saving
What is a Fixed Deposit?
A fixed deposit, commonly known as FD, is a savings instrument by the banks and other depository house. After investing in an FD, you place your money in saving account for a fixed time period, which can range from a few months to more than years. Once this term expires, you’ll receive your principal amount with interest acquired on your investment.
Benefits and Drawbacks of FDs
Benefits: FDs are one of the safest investment avenues since they give assured returns. Many banks, moreover, offer flexible terms accompanied with partial withdrawal facilities (with some penalty).
Disadvantages: FDs are liable to taxes-the higher return would lose some value after all the tax. Besides, FDs would generally fetch lower returns than other fixed-income securities where inflation rates have risen.
To Whom Should FDs be Recommended?
FDs are best suited to the conservative investor who wants to maintain capital intact with absolutely no risk of loss but earn a moderate, assured return. They prove to be useful for an individual having short-term goals in terms of monetary requirements who do not want to expose their capital to the uncertainty of instruments.
Public Provident Fund (PPF): A Tax-Saving Plan
What Is PPF?
The Public Provident Fund is a savings scheme promoted and backed by the government for a long-term savings account. It pays a fixed interest rate declared by the government on a quarterly basis, which proves to be quite higher than any regular savings accounts and even some FDs. Moreover, investment in PPF is tax-free up to a certain extent under the Income Tax Act in many countries, including India.
Advantages and Disadvantages of PPF
Advantages: PPF is a good source of tax-free returns for tax saving. It is a government-guaranteed scheme with stable returns and a long lock-in period of 15 years, which can be useful in the creation of wealth over a long period of time.
Disadvantages: The long lock-in period of PPF might be prejudicial to individuals who need liquidity. However, partial withdrawal is permissible after some years; still, the same is restricted.
Who Should Invest in PPF?
PPF is suitable for a long-term investor who needs benefits of tax and is also a suitable investment option for a conservative investor who seeks a safe investment coupled with after-tax advantages of reducing liability for tax.
Bond ETFs: A New-Fangled Investment in Bonds
What Are Bond ETFs?
 Bond Exchange-Traded Funds (ETFs) are investment funds that hold a diversified portfolio of bonds and trade on stock exchanges, just like stocks. Bond ETFs offer exposure to a wide range of bonds with no hassle as one has to buy individual bonds directly. They supply current income through interest payments, and shareholders can purchase or sell shares throughout a trading day.
Pros and Cons of Bond ETFs
Pros: It is the liquid asset that can trade like stocks. It can combine a variety of bonds within a single fund, thus diversifying investors’ portfolios. It carries far lower fees compared with many actively managed bond funds, and it also allows easy entry and exit.
Cons: As Bond ETFs are traded in the stock exchange, they are liable to market fluctuations. Additionally, if the interest rates increase, then the price of the bond ETF may decline. They also do not give capital protection that might have been offered by FD or PPF.
Who Should Invest in Bond ETFs?
Bond ETFs also work well for the investor who wants liquidity and thus wishes to gain broad exposure to the bond market without having to select individual bonds. They are also an ideal investment opportunity for the investor who is comfortable with minor fluctuations in the market.
Making the Right Choice
The three choices can be matched against each other on the basis of the following key points:
Risk Tolerance
If you are risk averse, then take a decision amongst government bonds, FDs or PPF as the returns are stable and the capital is protected. The former two would be apt if bond ETFs or corporate bonds do not have much to bear with minor variations.
Time horizon
The investment horizon would be short to medium if the time horizon is concerned. For this horizon, FDs and bond ETFs would be more appropriate as both these investments are liquid in nature. PPF, with its long lock-in period, suits long-term goals such as retirement savings.
Tax Implication
Tax efficiency is an important consideration in investment planning. The PPF provides tax-free returns; hence it is extremely attractive to the high-income-earners. Bond ETFs, as well as some bonds, are taxable with capital gains tax. FDs, on the other hand, are taxed according to the income tax slab of the investor.
Income Needs
If you want to create regular income, bonds and bond ETFs generate interest periodically, whereas FDs offer interest at the time of maturity or periodically as per the bank’s policy.
Conclusion
Each of the types of fixed-income securities addresses a different facet of the needs of investors, and selection essentially depends on your financial goals and risk appetite as well as an investment horizon. Bonds are ideal for delivering regular incomes, FDs ensure protecting the principal amount, and PPF delivers long-term growth accompanied by tax benefits. A bond ETF thus offers you the stability of the bond market and the liquidity of the stock market. It can therefore really help one strike the right mix to develop a well-rounded, risk-managed investment portfolio in line with his or her financial objectives.