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Mutual Funds: What are Fixed Income and Money Market Investments?
Fixed income refers to any type of investment that yields a pre-determined, regular or fixed return.
If a company wants to raise money to invest in new products, to make an acquisition, to buy equipment, it has two fundamental choices. It can either give away shareholding in return for investors funds, or it can leave its equity undiluted and promise instead to pay regular interest on money lent to it as well as return the original capital sum at the end of the loan period.
This latter method is usually called a bond as in my word is my bond. Governments can also raise money in a similar way in the form of Treasury Bills or Bonds.
Equally, a bank can offer a fixed rate of return on money you save with them (effectively you lend the bank your money.)
These are all examples of fixed income investments. Those investments which are short-term i.e. 12 months or less, are called money market investments.
It is useful to understand the terminology of fixed-term investments:
- The principal is the amount that is being lent
- The coupon is the interest rate that will be paid
- The maturity is the date by which the capital sum must be re-paid
- The issuer is the company or Government issuing the instrument
What are the different types of Fixed Income Investments available?
Fixed term securities offer different levels of return depending on the investment tenure and the degree of risk involved.
The following are short-term, money market instruments which are near-liquid and considered safe but, will not yield especially high returns:
- Treasury Bills (T-Bills) are short-term debt instruments issued and guaranteed by governments in order to raise funds from the public. T-Bills are purchased at a discount and redeemed at full value at maturity. The difference between the value at maturity and the discounted price at which you purchased it – your profit as it were – is the equivalent of an interest payment.
- Fixed Deposits are investments offered by commercial banks, with a fixed maturity date and interest rate. The interest rates offered will vary by the prevailing interest rate climate, the amount of money you invest and the length of time you are prepared to have the money locked away. These fixed deposits usually attract higher interest rates than T-bills because the risk of default is higher.
- Commercial Paper (CP) is a short-term debt instrument issued by a company.
- Bankers’ Acceptance is a short-term credit investment issued by a company and guaranteed by a bank.
- Bonds, as described earlier, are debt instruments issued by governments and corporations. They have longer investment tenure and higher yields.
- Bond prices have an inverse relation to market interest rates. In other words, if general market interest rates rise, then bond prices will fall and vice versa. You need to hold bonds until maturity to avoid any possibility of capital loss because if you sell them early in unfavourable conditions of high interest rates you could lose out.
What are their benefits of Mutual Funds?
- Fixed Income securities offer a great deal of security, regularity and therefore peace of mind. However, they don’t offer the same levels of return as shares or private equity investments in successful companies.
- They are also, depending on the length of time to maturity, easily liquidated.
Are they for me?
A component of fixed income investments can be useful within anyone’s portfolio to balance the overall risk/ return profile.
Fixed income investments generally become more relevant as your need for security increases. This often makes them more appropriate as one gets older. For example, a retired person can invest in a bond or fixed deposit and get a reliable income from the coupon / interest payment to cover his or her living expenses, knowing that the capital will be safely returned within a defined time-frame.
However, fixed return investments can be useful at any life stage depending on your goals.
What tips can ARM provide?
- Fixed rate investments are suitable when you need security of return, but they are still not entirely risk free.
- Remember that when inflation is high it can erode the value of interest payments.
- Also consider carefully the fact that bond prices fall when interest rates rise.
How do I start which Mutual Funds?
Contact your ARM Wealth Advisor to discuss the suitability of Mutual Funds in achieving your investment objectives. You can also buy online.
Last Update: June 19, 2017