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A quick guide to fixed income trading

It has long been a sound maxim of investing that it pays to have a diverse portfolio. Fortunately there are countless ways to invest from the more traditional stocks and shares to the more unusual such as classic cars and even whisky.

But many investors are also looking for less speculative ways to make their money work for them, ones which can also provide a fixed income. 

Bonds and ETFs

But what is fixed income, and how can an investor receive it?

One of the most popular ways of doing this is to invest either in bonds or bond Exchange- Traded Funds (ETFs).

A bond is a financial instrument that is a form of loan made by an investor to its issuer. The loan period is set and, over its duration, the investor is guaranteed to receive a fixed series of payments whose size is dictated by the promised interest rate. At the end of the bond’s fixed period it matures and the capital invested is returned to the investor.

ETFs consist of funds that contain a diverse portfolio of different bonds, and which can be traded on a daily basis. 

Types of bond

There are three main types of bonds available to buy. The first of these are called Treasury Bills. These are short-term bonds whose time to maturity generally ranges from between four weeks and a year. They have fixed values and the investor pays less than this figure to purchase them. By the time maturity arrives, they are then paid back the full value of the bond.

Long duration bonds are similar but have far long periods of time before they reach maturity, sometimes as long as ten years. Because they are issued and backed by the government they are considered to be some of the safest investment vehicles there are. 

The third on our list are corporate bonds. These are issued by organisations as a way of raising finance for themselves, perhaps for expansion or diversification into new markets. These are generally considered to be a more risky prospect than government issued bonds as they rely on the continued success of the company or organisation involved for investors to receive their due returns.

Why choose this form of investment?

Recent times have seen more and more investors turning to bonds and ETFs thanks to changes in the wider economy.

To understand this one has to look at the aftermath of the economic upheavals of 2008-9. For a long time since then interest rates were at historically very low levels. This meant that bonds were also offering similarly low rates.

But now that interest rates are on the rise, so are bond rates, often outstripping the rates that banks are offering for savers. On the minus side, interest rate rises are currently being used to try to contain inflation which, in turn, is reducing the real value of everyone’s money. However, bonds still make a lot of sense for investors.

The pros and the cons

There are a number of distinct benefits of fixed income investing in bonds and ETFs and these include:

Lower risk than stock market investments which can be subject to great volatility. By holding a certain amount of capital in bonds it can help to offset any losses.

It preserves capital because, at the end of the bond’s investment period you will still have the money that you started out with, as long as the lender remains in business and credit-worthy.

Fixed income generation in the form of regular payments from bond holdings make annual budgeting simpler and free from uncertainty. Certain bonds also offer the advantage of tax-free income.

Naturally, it’s also important to be aware of the risks which include:

Interest rate risk because when these rise, bond prices tend to fall and any you hold may become worth less.

Inflation risk which occurs when the rate of inflation outstrips the rate being paid by a bond, making it worth less than its original value.

Corporation Bonds credit risk that the issuer could default on the bond loan and the full value can never be recouped.

Liquidity issues can arise if no buyers can be found for the bond in question.

How to start trading

The good news for anyone who wants to expand their portfolio with the addition of fixed income trading is probably best to use one of the online trading platforms available.

This makes everything simple and straightforward – just what anyone would want from the relatively simple investment opportunity.

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