Types of Fixed Income Instruments
Bonds - Corporate & Government (treasury) & Municipal
Bonds vary in maturity and risk.
Corporate bonds encompass investment grade bonds with a rating between AAA to BBB. Compared to government bonds, corporate bonds carry additional risk and hence, additional return to compensate the investor for taking on that risk. These kinds of bonds are issued by large corporations and maintain a level of safety but still provide higher returns than government bonds.
Shorter term bonds like Treasury notes are government bonds with lower yields because of their lower interest rate risk and higher liquidity. Longer duration bonds like Treasury bills are exposed to more interest rates move and hence more interest rate risk. However, interest rates on government bonds are expected to decrease as the economy weakens so there may be too little income to be gained here.
Municipal bonds are issued by branches of the government - a city, state or government agency. These bonds are usually tax-free and investors buy them for their tax benefits. However, the market is dominated by small investors which makes the municipal bonds market not as efficient as other bond markets.
Fixed income ETFs or Mutual Funds
By investing in bond ETFs and mutual funds, the investor does not have to choose a single government or corporate bond. By purchasing ETFs and mutual funds, investors skip paying premiums and even get a discount for buying a large number of bonds. The Vanguard Long-Term Bond ETF provides investors with broad exposure, potentially higher returns and lesser risk.
A high-yield bond is described by its higher yield and higher risk than a normal fixed-income bond. It’s also known as a junk bond because its credit rating classifies it as non-investment grade. Investors purchase this asset to gain a competitive expected rate of return, similar to investing in the equity market but with lesser volatility. However, these bonds come with a high default risk as they are issued by companies with high debt ratios. Sometimes these bonds may just be from companies which lost good credit ratings due to previous defaults.
Preferred Stock (kinda)
Preferred stock contains characteristics that would classify it as both an equity and fixed income security. On top of that, preferred stocks are impacted by changes in interest rates. For example, when interest rates fall, the value of preferred stock increases and continues to provide dividend payments, almost in a coupon payment form. Preferred stock is also issued by larger-scale companies like insurance companies and banks - so they carry more guarantee of performance than buying common stock in a small capitalization asset.