When many people think about investing, the first thing that comes to mind is the stock market. And that’s not surprising, as the rise and fall of stock prices is constantly in the news. But if you’re going to achieve your financial goals, you may well need to look beyond stocks and include fixed-income investments in your portfolio.
Fixed-income investments offer three important benefits:
• Income – When you invest in fixed-income vehicles, such as bonds, Treasury securities and certificates of deposit (CDs), you receive regular income in the form of interest payments. And you continue to receive this income until your investment matures or you sell it, no matter what’s happening in the financial markets.
Of course, the income you can receive from fixed-income investments will always depend on the interest rates at which these investments were issued. But if you own a mix of long-term and short-term fixed-income investments, you can gain some protection against fluctuating rates.
When market rates are low, you can get greater income from your longer-term bonds, which typically – although not always – pay higher rates. And when market rates rise, you can benefit by reinvesting the proceeds from your shorter-term bonds.
• Diversification – If you were only to own stocks or stock-based mutual funds, your portfolio would be susceptible to higher risks, especially with market downturns. But you may be able to reduce the impact of market volatility by adding fixed-income investments to your holdings. Bond prices often move in a different direction from stocks, so if stock prices are falling, you might find that the value of your bonds is rising.
You can also diversify within the fixed-income portion of your portfolio by owning a mix of corporate and Treasury bonds, as well as CDs, just to name a few.
• Stability – As mentioned, you will always receive interest payments from your bonds if you hold them until maturity. But if you wanted to sell your bonds before they mature, you could get more or less, than what you originally paid for them. When market interest rates rise, the price of your current bonds will likely fall, as no one will pay you the full price for them when they get newer ones that pay more – this is what’s known as interest-rate risk.
Conversely, when market rates fall, the prices of your current bonds will probably rise. But here’s the key point to remember: Bond prices generally don’t fluctuate as much as stock prices. In other words, bonds are typically less volatile than stocks. Consequently, owning bonds can add diversification to your portfolio. And to maximize the stabilizing effects of bonds, you may want to stick with high-quality bonds rated as “investment grade” by independent bond-rating agencies.
How much of your portfolio should consist of fixed-income investments? There’s no one right answer for everyone. And over time, your interest in these types of investments may well change – for example, as you near retirement, you may want to consider shifting some of your growth-oriented investments into income-producing ones, though you’ll still need some growth potential to keep up with inflation. In any case, the combination of income, diversification and stability provided by bonds and similar securities should be compelling enough for you to find a place for them in your investment mix.