Fixed interest investments like bonds are one of many things you may find in an investment portfolio. What are fixed interest investments and how do they work?
Fixed interest is just one kind of asset class that you might find in an investment portfolio, but what are fixed interest investments and how do they work?
The most common types of fixed interest investments are bonds. These are issued by governments and corporations when they want to raise money, for example, to help fund a government or business initiative and are therefore considered lower risk investments.
By buying a bond, an investor is giving the issuer a loan. In return, the issuer pays the investor interest payments and repays the face value of that loan in full when the bond reaches its term.
Bonds are bought and sold on the secondary market, a trading place where investors buy and sell to each other. Unless they are held to term, the prices of bonds can fluctuate in a similar way to shares, but unlike shares, bonds can offer a degree of income certainty that share’s dividend cant.
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What are fixed interest investments?
The most common type of fixed interest investments are bonds. Bonds are issued by governments and corporations when they want to raise money to fund a government or business initiative.
Because they are backed by governments and large corporations, fixed interest investments like bonds are normally considered less risky than things like shares or property – though they still carry a level of risk. Government bonds are generally lower-risk assets; in return for their safety, they typically deliver a lower rate of interest to investors. Corporate bonds carry a higher level of risk but can deliver potentially higher interest payments over time.
How can you access fixed interest investments like bonds?
You can invest in bonds directly from the issuer (through a public offer on the primary market). Or you can buy or sell bonds on the secondary market, which is a trading place for investors, such as the Australian Stock Exchange or the Australian Bond Exchange. Bond transactions are generally managed by brokers or dealers at financial institutions which match bond sellers with bond buyers. Some bonds are listed on share markets or may be accessed through a managed fund or trust. Superannuation funds often invest in bonds as part of a risk diversification strategy.
How do fixed interest investments generate investment returns?
By buying a bond, an investor is giving the issuer a loan. The issuer pays the investor periodic interest payments and repays the face value of that loan in full when the bond reaches maturity or its end date. In the case of bankruptcy or liquidation, bondholders in a company are paid before shareholders. This means an investor in bonds would have a higher chance of receiving their money back as opposed to an investor in shares – meaning bondholders may have a degree of certainty that shareholders do not.
What can impact fixed interest investments?
There are risks for all investments, even defensive investments like bonds.The price of a bond depends on interest rates. Interest rates can change during the term of a bond, which means its price can rise or fall before its end date. The bond price may be different than the maturity price, which is the full face value an investor receives when a bond reaches its end date. The maturity price is set when the bond is issued whereas the bond price can change over time – particularly if the bond was purchased on the secondary market instead of being held consistently from issuance.
Inflation can also influence the buying power of your money – especially if the rate of inflation is higher than the rate of interest for a bond.
There is also a risk that an issuer will be unable to pay bond investors the interest on the bond and/or the maturity value. This 'credit risk' is reflected in credit ratings that are published by ratings agencies.
Why invest in fixed interest?
An investor may consider fixed interest investments like bonds for their traditionally defensive nature as well as their diversification benefits. This is often the case if the investor is older, approaching retirement or seeking capital preservation.
What you choose to invest in will depend on a number of factors, such as your age, life stage, personal circumstances and the advice you might receive from a financial adviser.
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Disclaimer
Information on this webpage is provided by Avanteos Investments Limited ABN 20 096 259 979, AFSL 245531 and Colonial First State Investments Limited ABN 98 002 348 352, AFSL 232468. It may include general advice but does not consider your individual objectives, financial situation, needs or tax circumstances. You can find the target market determinations (TMD) for our financial products at www.cfs.com.au/tmd, which include a description of who a financial product might suit. You should read the Financial Services Guide (FSG) available online for information about our services.