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Fixed Income Securities

IndianMoney.com Research Team | Posted On Wednesday, October 03,2018, 06:39 PM

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Fixed Income Securities

 

 

If you are risk-averse, consider investing in fixed income securities. Fixed income securities offer guaranteed returns. You enjoy returns in the form of fixed periodic payments and get the principal at maturity. Fixed income securities are an excellent investment for retirement.

After demonetization, banks cut savings bank interest rates and FD rates. Investors rushed to mutual funds with record investments via SIPs. Now, as the rupee depreciates against the Dollar (1 Dollar = Rs 73) and petrol prices in Maharashtra head above Rs 90 a litre, inflation must be controlled.

The RBI in its last two policy review meets has gone for back-to-back repo rate hikes. The repo rate has gone up from 6% to 6.5%. There are chances of a further rate hike in the month of October. The Government has increased small saving schemes interest rates and banks are offering higher rates on FDs. As mutual funds bleed, investors are rushing back to their beloved fixed income securities.

So what are fixed income securities? Let’s find out. Want to know more on Corporate FD? We at IndianMoney.com will make it easy for you. Just give us a missed call on 022 6181 6111 to explore our unique Free Advisory Service. IndianMoney.com is not a seller of any financial products. We only provide FREE financial advice/education to ensure that you are not misguided while buying any kind of financial products.

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Fixed Income Securities

Fixed income securities offer periodic income payments at interest or a dividend rate which is known in advance. The most common fixed income securities include treasury bonds, corporate bonds, CDs (Certificates of deposit) and preferred stock. Returns are on a fixed schedule, but amounts could vary.

1. Why invest in fixed income securities?

  • You may be tempted to invest in equity mutual funds and shares, but there’s risk involved. This investment is high returns at high risk. You could earn or lose a lot of money. Fixed income securities offer guaranteed returns and are good for risk-averse investors.
  • Interest is not very high, but returns are guaranteed.
  • Some investments offer tax-free returns. Though interest is not high, tax-free returns are an attractive incentive.
  • You cannot build a portfolio purely on equity. You need fixed income securities for diversification.
  • With interest rates rising, fixed income securities are an excellent investment.

2. Types of fixed income securities

Fixed Deposits:

  • Fixed deposits called FDs are an excellent and popular form of investment in India. You can invest even Rs 500 for 7 to 10 days. Banks are hiking interest rates across maturities. HDFC Bank offers 7% interest on deposits below Rs 1 Crore. ICICI Bank, Axis Bank, IDFC Bank and some other banks offer interest above 7%, on FDs from 7 days to 10 years. Senior citizens are offered up to 0.5% higher interest on FDs and you can invest in 5 year tax-saver FD to enjoy tax benefits under Section 80C.

Company fixed deposits:

Company FDs offer higher interest than bank FDs, but are slightly riskier. Invest in Company FDs with the AAA rating which may offer 1% higher returns than bank FDs. Lower rated Company FDs may offer even higher returns, but you must exercise caution.

  • There is no assurance of safety in Company FDs.
  • They don’t offer tax benefits.

Recurring deposits:

These are similar to SIPs in mutual funds. You invest small amounts regularly (once each month) for a fixed duration. Interest is similar to bank FDs. You get a lump sum at maturity along with accumulated interest. Senior citizens get higher interest. Banks offer 6-7% interest on RDs.

Liquid funds:

Liquid funds are a type of mutual funds which invest mainly in money market instruments like certificates of deposits (CDs), treasury bills, commercial paper and reverse repo.

  • They offer higher interest than savings bank accounts.
  • High liquidity and you can withdraw investment at any time.
  • There’s no lock-in and exit load. Liquid Plus schemes may have exit loads.
  • You can invest even Rs 500 in liquid schemes.

Fixed Maturity Plans:

Fixed maturity plans popularly called FMPs are closed-ended mutual funds with fixed maturity and invest pre-dominantly in debt. You can invest in FMP only during the days open for subscription via NFO.

FMPs invest in certificates of deposits, corporate bonds, commercial paper and other money market instruments. The fund manager invests money in financial instruments of similar maturity. If your FMP has a maturity of 4 years, then the fund manager invests money in corporate bonds of maturity 4 years. FMPs follow the buy and hold strategy. There is no frequent buying and selling, keeping expense ratio low.

Returns on FMP: The returns from the FMP are indicative yields. Returns offered are indicative, but not assured. Returns could be higher or lower than indicated in the NFO.

Taxation on FMP: FMPs are an excellent investment if you fall in the higher tax brackets vis-à-vis FDs. Capital gains on FMPs if held for less than 3 years are called short-term capital gains (STCG). These gains are added to taxable salary and taxed as per tax brackets. Capital gains on FMPs if held for more than 3 years are called long-term capital gains (LTCG). LTCG enjoys the indexation benefit. (Returns are adjusted for inflation and this means lower taxation).

Debt mutual funds:

Debt mutual funds invest in short term and long term bonds across maturities. They invest in money market instruments like certificates of deposits (CDs), commercial paper (CP) and treasury bills. A debt fund portfolio invests in bonds of varying maturity.

Take a look at the modified duration which is the measure of price sensitivity of the debt portfolio vis-à-vis interest rates. If interest rates go up or down by 0.5% in a particular month, the NAV will go up or down by 2%, if the modified duration is 4 years. Yield to maturity (YTM) is what a bond earns from coupon/interest payments and also annualized gains/loss on purchase price if held till maturity.

How to choose debt funds?

  • Invest in a debt fund whose maturity term matches your investments goals and time horizon.
  • Debt funds invest in highly safe Government bonds and high-risk corporate bonds. Bonds are assigned a credit rating based on risk associated with it. High credit rating means a safe investment.

3. Which fixed income securities are good in a rising interest rate scenario?

You are in a rising interest rate scenario. This is when bond prices fall as interest rises. You will find bond NAVs falling. In periods of high interest, its best to avoid long duration bonds which are highly sensitive to rate movements and prices crash. It’s best to opt for short term funds in rising interest rate scenario like FMPs and liquid funds.

4. Benefits of fixed income securities:

  • You enjoy steady income.
  • You get the benefit of capital appreciation.
  • Helps diversify investments.
  • Safe haven in an economic downturn.
  • Stability of principal.
  • Liquid funds and liquid plus schemes have high liquidity.
  • They are ideal for conservative investors.
  • Excellent investment in a rising interest rate scenario.

5. Risks of fixed income securities

Credit risk: If the Company financials are not sound, they could default and investors lose principal. IL&FS a reputed Company in financial services, defaulted on bank loan interest payments and also term and short-term deposits. It also defaulted on commercial paper obligations.

Interest rate risk: When interest rates rise, prices of long duration bonds fall. New securities are available at higher prices and offer a higher yield. Investors lose interest in the older securities. Invest in short term debt during rising interest rate scenarios.

Reinvestment risk: This happens when the security you invested can’t fetch the same returns at maturity or at the time of reinvestment. This happens in a falling interest rate regime.

Price risk: A number of fixed income securities are listed on stock exchanges. Many investors might want to exit fixed income securities before maturity. The prices of fixed income securities are impacted by interest rate movement and volumes of trading. You might exit the investment in periods of low liquidity and not get the right price for it.

Purchasing power risk: If the returns from fixed income securities are not able to beat inflation, this is purchasing power risk. You have to consider returns after taxation and these returns must beat inflation.

PPF is an excellent fixed income investment which currently offers returns of 8% effective October 1st 2018 and returns are not taxed. It offers inflation beating returns.

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