Last Updated on May 25, 2022 by Neera Bhardwaj
When it comes to investment avenues, there are two distinct types of instruments that you would find in the market – equities and fixed income securities.
Equities are those whose returns are dependent on the market while fixed income securities offer lower but fixed and timely returns. In this article, we dive deep into what fixed income securities are and their features.
Table of Contents
What are fixed income securities?
Fixed income securities are those that promise a fixed rate of return on the invested amount at a predetermined time. This return is called the interest or the coupon, and it is paid periodically. For example, if an asset promises a 6% per annum rate of interest payable annually, and your deposit Rs 10,000, you would earn Rs 600 every year on your deposit, irrespective of market movements.
Features of fixed income securities
Fixed income securities have a few salient features which are mentioned below.
- The highlighting feature of fixed income is safety of capital and assurance of returns.
- You do not suffer any capital erosion since such securities are immune to market volatility.
- The fixed-income security is offered for a specific tenure after which it matures.
- In some cases, the rate of interest remains fixed over the tenure of the security while in others, the rate might change every year or quarter.
- The interest on the investment can be paid quarterly, half-yearly, or annually.
- Some assets allow you to avail of the interest income as and when it is accrued. In other cases, the accrued interest and the principal (amount invested) are paid on maturity.
- Some fixed income securities can also be traded on the stock exchange. In such cases, their market value fluctuates but the interest rate remains fixed.
Types of fixed income securities
There are different types of fixed income securities that are available in the market. Some of the most popular ones include the following.
Government bonds are synonymous with fixed income securities. They are a way to raise money from investors to fund projects. Governments and companies issue bonds with a fixed rate of interest and every bond has a specific maturity period. You can also trade the bonds on the stock market after a short tenure. Tax-free bonds offer tax advantages to the investors wherein there is no tax on the principal amount or on the interest accrued.
One of the most popular fixed income securities, fixed deposits are issued by banks, post offices, and NBFCs. You can invest a lump sum amount for a fixed duration and at a fixed rate of interest. 5-yr FDs with banks and post offices also earn a deduction under Section 80C of the Income Tax Act, 1961 and helps you save taxes upto Rs 1.5 lakh in the financial year.
Another type of deposit scheme offered by banks and post offices, recurring deposits are where you invest a sum of money periodically, usually, every month. You can choose the amount and the tenure of deposit, and the interest is accrued depending on the corpus accumulated in the duration.
Public Provident Fund (PPF)
A tax-efficient investment avenue, PPF investments qualify for the EEE category of taxation. This means, while the amount you invest in PPF is tax-free, the interest earned is also tax-free and there is no tax on the final amount you withdraw either. It is, however, a long-term saving scheme with a tenure of 15 yrs which is extendable in blocks of 5 yrs. The interest rate is decided upon by the government and reviewed on a periodic basis. You can start investing with as little as Rs 100 and the maximum investment in a year is limited to Rs 1.5 lakh.
National Savings Certificate (NSC)
One of the most popular tax-saving investment avenues of yesteryears, the NSC is issued by the government and can be invested in through the post office. The rate of interest is fixed and reviewed by the government regularly. The tenure is 5 yrs and investment up to Rs 1.5 lakh earns you a tax deduction under Section 80C.
Senior Citizen Saving Scheme (SCSS)
A savings instrument for senior citizens aged 60 yrs and above, SCSS is offered by the government. It gives tax benefits on investment under Section 80C. You can invest a minimum of Rs 1,000 and a maximum of Rs 15 lakh under the scheme in a lump sum and get quarterly incomes in the form of interest earnings.
Sukanya Samriddhi Yojana (SSY)
A savings scheme for the girl child, SSY can be opted by parents or guardians of a girl child aged below 10 yrs. The minimum deposit is Rs 250 and the maximum in a year is Rs 1.5 lakh. Deposits are allowed as a deduction under Section 80C and they also earn a fixed rate of return as determined by the government. The tenure of the product is however very long drawn – until the child attains 21 yrs of age, or is married after attaining 18 yrs.
Certificate of Deposits
CDs are issued by banks and financial institutions at a guaranteed rate of interest, much like fixed deposits but with a shorter tenure.
Benefits of investing in fixed income securities
Fixed income securities offer various types of benefits to investors and that is why they are popular among many. Some of the main benefits of these instruments are as follows.
First and foremost, fixed income avenues offer complete capital protection. The money that you invest in the scheme is not exposed to volatile market movements. On maturity, you get the amount that you have invested plus the interest. This makes it a safe haven for risk-averse investors.
As the name suggests, fixed income instruments offer a fixed rate of interest. The returns are not dependent on market performance. So, even when the markets are volatile or bearish, fixed income securities would give guaranteed returns on the predetermined date.
Most fixed income avenues give you tax benefits. For instance, investment in PPF, SSY, SCSS, NSC and 5-yr fixed deposits, among others, is allowed as a deduction from your taxable income under Section 80C up to Rs 1.5 lakh. Similarly, the interest earned in some cases is also exempted from tax. Thus, fixed-income avenues can help you enjoy tax benefits while creating a guaranteed corpus.
Suitable for financial goals
You can plan your medium- and long-term financial goals with the help of fixed income securities. With fixed returns, you can invest in these securities and plan a secured corpus for your goals.
Risks associated with fixed income securities
Though fixed income securities are not prone to volatility risks of the market, they do face the following types of risks.
Credit risk is the risk of default by the issuing institution. If the issuer of the security fails to pay the security on maturity, it gives rise to credit risk. For example, corporate bonds are exposed to credit risk. If the issuing institution fails to honour the bond on maturity, the investor would lose their investment. This however is minimal in cases where the government is the issuer.
Interest rate risk
Interest rate risk is the risk of the interest rate rising after you have invested in the security. For example, if you invest in a fixed deposit at an interest rate of 6% and then the rate rises to 6.5%, you lose out on the additional interest rate. Some fixed income securities have floating interest rates. For example, the interest in PPF or SSY is reviewed periodically by the government in view of the inflationary pressures on the economy. The trend over the past decade has been negative and interest rates have been constantly on the decline.
Inflation risk is the risk of inflation eating into your returns. If the inflation rate exceeds the rate of interest paid by the security, the effective return that you earn would not have real worth. As the purchasing power of money has reduced, the effective returns would be low. This is the greatest risk that fixed-income securities face.
If you are a risk-averse investor who wants to earn guaranteed returns, fixed income securities may be considered for your portfolio. You can choose from the different types of fixed income securities and build up a diversified portfolio. Debt mutual funds offer this diversification within a single product.
Even if you have a good risk appetite, you can invest in fixed income securities to bring some stability to your portfolio and create a fall-back option. However, do remember the risks associated with investing in these types of securities and choose avenues that have suitable tenure and interest rates to help you meet your financial goals.