Thursday, February 22, 2024
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Home » How Fixed Income Investments Can Help Build Wealth Over the Long Term

How Fixed Income Investments Can Help Build Wealth Over the Long Term

by Ryan Hughes
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Building long-term wealth is a goal shared by many individuals seeking financial stability and security. Although equities and other high-risk assets frequently dominate discussions on investment strategies, it is essential not to overlook the significance of fixed income investments in maintaining a well-balanced portfolio. They provide a steady stream of income, capital preservation, and predictability that can complement higher-risk assets and contribute to long-term wealth creation.

In India, fixed income investments account for approximately 70% of all investment assets, indicating their widespread popularity and importance in financial planning and their benefits.

Role in diversification

Fixed income investments are currently offering attractive interest rates ranging from 8.5% to 9.36% annually, nearing an all-time high for FD (fixed deposit) rates in India. As investors strive for financial success and stability, many adopt a balanced approach in their portfolios, allocating approximately 50% to stocks and 50% to fixed income. This balanced approach aims to mitigate risk and enhance long-term returns.

Diversification is essential for minimizing risk in investments. Fixed income investments, like fixed deposits and bonds, play a unique role in this strategy by offering low volatility and steady income, which balances the fluctuations of higher-risk assets like equities, leading to overall portfolio stability.

Uniquely diversifying one’s portfolio is prudent for risk management, but concentrated strategies offer potential for higher long-term growth. However, they come with increased risk, and finding the right balance between diversification and concentration is crucial for individual circumstances.

Fixed income strategies

The barbell strategy coined by Nassim Nicholas Taleb, is a distinct approach to the above-mentioned risk management. When implementing the barbell approach in fixed income portfolios, investors are advised to combine short-term investments with longer-term ones. Additionally, the strategy can be extended to a broader wealth portfolio. Such a portfolio might consist of a well-balanced combination of ultra-safe investments, index funds that track major markets, and alternative investments strategically aimed at achieving significant returns.

On the other hand, the laddering strategy is a time-tested method used in fixed-income investing to reduce risk and take advantage of changing interest rates. It involves diversifying investments across various maturity dates.

For example, let us consider an investor with ₹20 Lakh to invest in a fixed deposit. Rather than depositing the entire amount into one long-term deposit, the investor can split it into five smaller fixed deposits maturing in one, two, three, four, and five years, respectively. As each deposit matures, the proceeds can be reinvested at prevailing interest rates for new fixed deposits, allowing for greater flexibility and potentially higher returns.

By strategically managing risk, investors can safeguard a substantial portion of their wealth while also capitalizing on market upswings and exponential growth opportunities.

Credit-worthiness

Credit-worthiness is a crucial aspect when investing in fixed-income securities such as bonds. It significantly impacts the safety and potential returns of the investment. Reputable credit rating agencies play a vital role in providing credit ratings for bonds, aiding investors in assessing the associated risk.

Bond mutual funds and exchange traded funds (ETFs) present a convenient option for investors seeking diversification and professional management. By pooling money from multiple investors and investing in various fixed income instruments, these funds offer instant diversification and easy access to the bond market. Opting for bonds with higher credit ratings indicates lower default risk and a higher probability of receiving interest payments and the principal amount at maturity. Additionally, by reinvesting the interest earned instead of withdrawing it, the growth of the investment can be accelerated, leading to enhanced overall returns over time.

Using fixed deposits

Amid tightening liquidity and strong credit demand, lending institutions fiercely compete for deposits. Small finance banks (SFBs) now offer significantly higher FD rates than public sector banks and private banks, making fixed income investments more appealing. These fixed deposits play a crucial role in long-term wealth creation by providing stable income, capital preservation, and diversification benefits. For a secure financial future, a well-balanced portfolio combining fixed income and higher-risk assets is essential. Moreover, fixed deposits are not limited to retirement planning; they offer stability and consistent returns for younger investors, acting as a safe haven during market uncertainties.

Adding to the appeal, the DICGC insurance scheme provides a valuable safety net for depositors, ensuring their savings are protected up to ₹5 lakh in case of a bank failure. With this assurance, depositors can have peace of mind and maintain their confidence in the banking system. In addition, to align fixed income investments with specific goals and risk tolerance, seeking guidance from a qualified financial adviser is highly recommended. With this comprehensive approach, investors can navigate the financial landscape with confidence and achieve their long-term aspirations.

Source : Mint

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