What Is Fixed Income Investing?

Bonds, Annuities, Money Market, Private Lending & More 

We recently shared a video and blog post that gave all the details about our strategy for investing in the stock market. We talked about the investing mistakes we’ve made, the approach that we fine-tuned over the years, and what stock market investments we currently hold. That video covered our equities side of our portfolio and, afterwards, we got a lot of questions about the fixed income side of our investments. 

To help answer the questions of which fixed income investments we hold, we’re providing a primer on what fixed income investing is, the role it plays in a portfolio and why fixed income investing might not be right for you. 

As a refresher, our investments are a mix of equities and fixed income. For equities we hold a low-cost global index fund, so that gives us a slice of the entire global market. For fixed income, we invest in syndicated mortgages that provide us with regular interest payments. These are what fund our day-to-day living expenses.

Fixed income vs equities

Fixed-income investments are those where you loan your money to a third party in exchange for an agreed-upon rate of return or interest payments. These payments are provided to you by the borrower on a fixed schedule. At the end of the loan period, you receive back your original investment amount. So your overall gain would be the total amount of interest that you’ve received. 

This is different from investing in the stock market where you are investing in an asset that can increase or decrease in value. During times when there is economic growth — like the last decade — the value of those investments can grow significantly. But they can also decline in value during periods of recession or market volatility. 

You don’t know how much growth or loss you will see by the time you are ready to cash in your investment. However, the market has been shown to grow over the longer term so you are making a bet that you will see a decent return. 

That brings us to the key difference. With fixed income investing, you generally know how much you’re going to make. With the stock market, you don’t know how much you’ll make but you expect to come out ahead over the long term. 

Types of fixed income investments

The most basic type is the kind that you can just get from your local bank. These are called certificates of deposit in the US or guaranteed investment certificates in Canada. You can choose the length of time for the investment, whether its months or years. Although the rate of return will be better for longer investment periods, typically the interest is still quite low; these days it might be a couple percentage points or even less. 

Another common type of fixed income investments are bonds.Traditionally bonds were purchased through a broker. Whether they were corporate bonds, or government bonds, they would be for a specific duration at a fixed rate of return. Today many people invest in bonds through mutual funds or exchange traded funds. These funds aim to track a bond index, which could be composed of government bonds or corporate bonds or municipal bonds, just to name a few types.  

These funds offer some benefits over purchasing individual bonds. A fund is diversified, since it’s based on a large group of bonds, not just one or two. And you can remain invested over a long period or sell at your convenience. On the other hand, the value of holdings in a bond fund may fluctuate over time. This is unlike individual bonds which are a fixed investment for a fixed return. 

As an asset class in general, the rate of return for bonds can differ quite a bit depending on the type and level of risk. However, bonds are a lower risk investment and offer a lower return versus equities. 

Another popular type of fixed income investment are annuities. These are typically seen as part of a retirement plan sold by insurance companies. You would deposit an initial sum of money or make a series of payments. You are then guaranteed regular payouts later in life, such as when you turn 65 and are ready to retire. These payouts could be for a defined period, like 25 years, or could be for the rest of your life.

The rate of return for annuities will generally be even lower than the return on a similar investment into bonds. That’s the price you pay to have your investing taken care of for you.

The next type of fixed income investment is a money market account. These are available from a bank or credit union. They have some similar features to regular chequing and savings accounts in that you can make withdrawals and write cheques. They do pay a slightly higher interest rate than a standard savings account but usually a higher balance needs to be maintained. 

There is a fifth type of fixed income investment that we wanted to discuss today, which is private lending. These are what we invest in and we’ll take you through in a moment. But first…

What role does fixed income play in a portfolio?

Since fixed-income investments are known to provide a lower return over time versus investing in equities, why bother investing in fixed income? What role does it play in a portfolio?

Fixed income investments provide a number of benefits. First, while the rate of return is usually lower, fixed income investments don’t see the highs and lows you get from investing in the stock market. So including some fixed income investments helps reduce the volatility of your portfolio. 

Fixed income investments also pay out regularly. With all the examples we just talked about, they provide an income stream throughout the life of your investment. 

Finally, since the returns aren’t directly correlated with the stock market, fixed income investments also add diversification to your portfolio. Effectively, by adding fixed income to your portfolio, you’re not putting all your eggs in one basket. These are components of a financial risk management strategy.

Allocation of portfolio

Ultimately the allocation of fixed-income investments in your portfolio is a very personal decision based on your circumstances and financial goals but there are a few factors to consider.

You would want to consider including fixed income investments if…

…you are uncomfortable with the risk and emotional rollercoaster of a 100% equities portfolio

…you have a need for an investment with regular payouts and feel that stock dividends wouldn’t be enough to meet your needs. This was an important point for us when we were planning our early retirement. We wanted an income flow that would effectively replace the paychecks we were so used to receiving. 

…or if you need to access your funds within a shorter time horizon, such as five years. 

Fixed income will definitely give you back your original investment plus interest within five years while equities may or may not. 

Our fixed income investments

We invest in syndicated mortgages, which is a form of private lending. These are large construction loans, either residential or commercial, that are split up among many different lenders. We invest in a tiny piece of a mortgage — sometimes just 1 or 2% — and we have built a portfolio of a number of these mortgages.

We like this type of investment because it provides exposure to the real estate market without the complexity of owning property ourselves. As well, the yield is much higher than other types of fixed income, like bonds. 

Of course, higher returns usually come with higher risk, but there are some ways we can manage the risk. The loans are always backed by a property asset, so we do have that reassurance in case the borrower defaults. We also choose to only invest in first mortgages, and lend below a maximum of 75% of the property value. 

This type of investing is not suitable for beginners because of the due diligence required when selecting which loans to invest in. That said, if you’re interested, there are mortgage investment funds available as a more passive version of this type of investing.

No fixed income?

Now let’s talk about why you might not want any fixed income in your portfolio. If you’re more than 10 years away from retirement, you might be better off focusing on wealth accumulation and growth. This means having a portfolio with a very high proportion in equities where you’ll see the greatest potential for growth.

Fixed income typically has a larger role to play if you’re worried about wealth preservation, not growth. We have a large proportion of our portfolio in fixed income but we just retired within the past year and our major concern is minimising financial risk within our first few years of retirement. If you’re far from retirement, you can consider continuing to grow your wealth instead of preserving it.

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