Fixed Income Investments: Should You Have Some?

Now, we know that saving money is wise, and that our savings should be diversified. We've discussed the four steps to wise investing; now let us delve deeper into the realm of fixed income to determine whether or not it might be a valuable component to your portfolio.

Let us first discuss what fixed income products are: essentially, they are products that will provide you with an income stream. They may include things like bonds, GICs, mortgage backed securities, pooled mortgage mutual funds, income trusts, and even real estate funds and trusts.

These types of products will provide you with an income stream based upon interest rates, or in the case of income trusts and real estate funds, income, rents or royalties.

The reason to own them is simple - they tend to be less volatile than equity, which can provide your portfolio with some stability. Further, the continuous flow of income into your portfolio can be a welcome addition in times of serious volatility. It can be comforting to know that cash is continuing to come in, even though the values of some of your other products are declining.

So, the question becomes, how much is correct for you? This can only be determined by undertaking an objective assessment of your tolerance for risk. The more comfortable you are with risk and volatility, the less fixed income you should hold versus equity. Therefore, the less comfortable you are with risk and volatility, the more fixed income you should hold.

Fixed income products themselves can be rated according to risk: GICs are significantly less risky than bonds, bonds (usually) less risky than income trusts. Ultimately, the total risk of the product will be based upon what guarantees are associated with it, and what degree of diversification can be found in the underlying holdings.

Fixed income products are usually very sensitive to interest rate changes. For example, when dealing with bonds, the "coupon" rate or rate of interest paid back to the bondholder is set at the time the bond is issued, and will be in some way related to the current interest rate environment. Because bonds can usually be traded on the open market, their market value is determined by the length of time they have to maturity coupled with their current "coupon" rate. Due to these factors, if a bond is issued and then interest rates fall, the value of the bond will go up, as new bonds that are issued are likely to be issued at a lower coupon rate, thereby making the first issued bond more attractive to investors, as the income from the bond will be higher.

Similarly, if a bond is issued and then interest rates go up, the value of the bond will decrease as new bonds issued will likely have a higher coupon rate attached to them.

GICs, on the other hand, can not be traded on the open market, and are generally considered to be fairly safe. What you buy is what you get.

Ultimately, having a fixed income position can be a useful way to reduce your portfolio volatility, and can provide you with opportunities for rebalancing, as fixed income and equity cycles do not tend to correlate very closely.

As always, consider discussing things with your advisor.