Wrapping up our 6 part fixed income educational series
Top 10 take-outs
We covered a lot of ground with our educational series and introduced many new terms and concepts that you may not have been familiar with. So, let’s have a look back at 10 of the top take-outs.
- Fixed income is an investment where the investor lends money to a borrower or issuer. The issuer then makes payments of a fixed amount (or an amount linked to a benchmark), on a fixed schedule of dates, and pays back the principal on a fixed date. This definition captures both TDs and bonds, it does not cover hybrids, or riskier investments such as property or shares.
- The four key characteristics of bonds are:
- The face value – (the principal re-paid when the bond matures),
- The price you paid – either the face value if you bought at issue, or the market price paid after it was issued,
- The coupon – the steady stream of income paid over the life of the bond,
- The term – the time from issue date to maturity, or the time left to the maturity date if you buy it after it was issued.
- Corporate bonds can have fixed or floating rate coupons. Floating coupons are pegged to an industry benchmark offering a fixed margin above that benchmark.Corporate bonds can have fixed or floating rate coupons. Floating coupons are pegged to an industry benchmark offering a fixed margin above that benchmark.
This means you can either lock down a fixed rate of income (with a fixed coupon bond), or if you think interest rates are likely to move upwards during the term of your investment, you may prefer to invest in a bond with a floating coupon rate as that coupon will move up and down with interest rate changes.
- A well-diversified portfolio should include some allocation to fixed income whatever your stage of life. Remember the rule of thumb: “your bond allocation should roughly equal your age” and use this as a gauge to see if you are in the right region.
- Make sure you know where your investment sits in a company’s capital ranking. In the event the company gets into financial trouble, some securities will be paid out before others and equity holders are the last to be paid out.
Use this handy scale to check where your investments sit:
- In a similar way to ASX bringing government bonds to investors with AGBs, XTBs have now made the benefits of corporate bonds accessible to ASX investors. XTBs combine the predictable income and capital stability of corporate bonds, with the transparency and liquidity of ASX.
- Check that you hold a variety of investments across the different asset classes to ensure you have a well-diversified portfolio. But, don’t stop there – also make sure that you have the right securities in the right areas. Check if you have hybrids sitting within the defensive area. If you do, you may want to consider moving them into your growth area and replacing them with a fixed income investment. A replacement could be corporate bonds or XTBs, fixed income ETFs or managed funds or a Term Deposit.¹ Make sure every part of your portfolio works as hard as it can. If you can achieve a better return with a corporate bond or XTB than a TD that could be a consideration.
- If you decide you want to make some changes and include an investment in XTBs, there are a number of ways you can select from those available to meet your needs. A few of these include yield to maturity, credit risk and laddering.
- Use the predictability of returns of corporate bonds to your advantage. What other investments can accurately tell you on the day you invest what your exact return will be?
It takes a little bit of a mind shift from the unpredictable world of equities, property and even hybrids. Once you’ve got the hang of it the benefits of including fixed income amongst your investments can be rewarding.
- Don’t forget to factor coupons into all calculations of returns. Don’t just focus on the price. Yield to maturity is the true measure of total returns for bonds and fixed coupon XTBs. Finally, always remember, if you’re interested in an investment in corporate bonds and XTBs but aren’t sure which would be suitable for your needs, it may be worth speaking to an adviser for their professional opinion.
You’ve now had chance to form your own view of whether an allocation to XTBs is right for you. So this is a good time to check how to buy and sell XTBs.
¹Term Deposits may enjoy the benefit of protection under the Financial Claims Scheme.