When it comes to investments, there are many options available to investors who seek to grow their wealth. Fixed rate bonds are one such option that offer a fixed rate of return over a set period. In this article, we explore what fixed rate bonds are, how they work, their advantages and disadvantages, and the difference between fixed rate bonds and floating rate bonds.
Though fixed-rate bonds are often categorised as traditional ones, they have their share of attractions. Investors who have no immediate need for extra cash or are looking for ways to generate steady yet assured returns on their current savings find this bond suitable.
What are fixed rate bond?
Fixed-rate bonds, also known as fixed-income securities, are a type of debt instrument that guarantees a fixed income. These bonds have a fixed interest rate throughout their term and a specific maturity date. In other words, the interest payments are known in advance. Therefore, fixed-income securities offer investors a reliable stream of fixed interest payments known as coupon payments.
Both governments and private companies issue these bonds. They can be short-term or long-term bonds. Governments or companies issue these bonds to raise capital for financing their business operations. The government or company issues a bond for a specific price and a fixed term, which an investor purchases. In return, they offer regular interest payments to the investor. Finally, they return the investment at the bond’s maturity. In other words, the face value is the amount the investor will receive when the bond matures.
Fixed-rate bonds are suitable for investors who intend to generate guaranteed interest rates over a specific period. Furthermore, investment in these bonds provides robust protection for the deposited amount. Hence, when the bonds mature, the bondholders receive the initial principal amount along with the interest. Moreover, long-term bonds typically yield higher interest rates compared to short-term bonds.
How do fixed rate bonds work?
When a company or government issues a fixed rate bond, it outlines the interest payments the bondholders will receive throughout the bond’s term. The bondholder will receive these payments at a fixed interest rate of the bond, which could be a higher or lower rate depending on the issuer's creditworthiness and market conditions.
Fixed rate bonds can have different maturity periods. Investors receive their principal investment back upon the bond's maturity. However, investors who want to cash out before maturity might incur a loss or a gain depending on the bond’s current market prices.
Benefits of a fixed rate bond
There are plenty of benefits to a Fixed-Rate Bond savings plan, some of which include:
- A guaranteed interest rate for the full length of the term: This means there's no chance of the interest rate fluctuating. You know exactly how much money you'll get back when the bond matures.
- Higher interest rates than typical easy-access savings plans.
- Fixed-Rate Bonds are a good way to diversify your financial portfolio: Having one of these means you have back-up funds waiting for you further down the line, complementing your other financial strategies.
- With Shepherds Friendly, your savings plan is kept safe and steady for the whole term as your bond has guaranteed protection.
- One of the biggest appeals of a Fixed-Rate Bond savings plan is that it provides certainty: You know precisely how long your money will be invested and what interest rates will be locked in, so there's no question about its value when it matures.
Advantages & disadvantages of fixed rate bonds
Like most investment options, fixed rate bonds have their share of advantages and disadvantages.
Advantages:
- Predictable and steady income: One of the most significant benefits of investing in fixed rate bonds is the predictability and steadiness of the income received. This makes fixed rate bonds an excellent investment option for those seeking a stable income flow.
- Low-risk investment option: Fixed rate bonds offer a lower risk option compared to stocks, making them a safer investment choice. Investors are assured of a fixed return and risk low to no loss of their investment principal.
- Guaranteed return on investment: Fixed rate bonds offer a guaranteed return on investment, which makes them an attractive choice for those seeking to invest in a stable and secure investment vehicle.
Disadvantages:
- Lower potential returns: Fixed rate bonds offer lower returns compared to other investment options like stocks and mutual funds. This is because they are generally safer investment instruments than stocks.
- Changes in Opportunity cost: Investment returns don't keep up with inflation over time. Therefore, there is always the risk that fixed rate bonds' return may not be high enough to keep up with the changing economy's inflation rates.
- Interest rate risk: Interest rates in the market can change, and this can affect the bond's return. This means if the market interest rates rise, it could impact the fixed rate bond's value.
Who Should Invest in fixed rate bonds?
Fixed-rate bonds are among the safest investments in India. They are ideal for investors with a low-risk tolerance who prioritise safety over potential high returns. Unlike market-linked instruments such as stocks, which offer uncertain capital appreciation, these bonds provide a more predictable long-term investment option, especially for those new to the stock market.
Typically, fixed-income securities carry lower risk. They can be a good choice for investors with limited time to recover from potential losses. However, it's important to consider inflation risk, which can erode the value of investments over time. Additionally, fixed-rate bonds can offer a steady income stream.
In conclusion, investors seeking consistent and fixed returns over a specific period may find these bonds suitable. They can help grow investments over time to fund retirement or other long-term goals. Furthermore, investing in these bonds can help diversify a portfolio, reducing overall risk.
Difference between fixed rate bonds and floating rate bonds
The following table shows the difference between fixed rate bonds and floating rate bonds –
| Parameter | Fixed Rate Bond | Floating Rate Bond |
| Meaning | These bonds are known as fixed-rate bonds as the interest rates remain fixed throughout the tenure. | These bonds are known as floating-rate bonds as the interest rates tend to fluctuate throughout the tenure. |
| Interest Rate Risk | A fixed-rate bond is very sensitive to the interest rate risk. | Floating-rate bonds do not expose investors' deposits to interest rate risk. |
| Maturity Amount | Investors are aware of the final amount they will receive at the end of maturity. | Investors find it challenging to ascertain the final maturity amount due to the variable interest rates. |
| Coupon | Investors receive a fixed coupon payment either monthly, half-yearly or yearly throughout the investment tenure. | Investors receive a variable coupon rate throughout the investment tenure i.e., when the interest rate rises, the coupon rates also increase and vice versa. |
| Financial Planning | Investing in fixed-rate bonds helps in proper financial planning and it helps in aligning the investment to a financial goal. | One can build a proper financial plan with floating-rate bonds as the returns may or may not align with a specific financial goal. |
Conclusion
Fixed rate bonds can provide a predictable and safe option for investment, especially for those seeking a guaranteed flow of income. While there is the potential for consistent returns, investors should consider the various risks and advantages before investing. The fixed rate bond remains an ideal investment instrument for risk-averse investors seeking financial security.
If you're considering taking the first step towards building a diversified investment portfolio, now is the perfect time to explore the world of bonds. Bajaj Finserv can be your partner on this exciting journey. Start your bond journey today for a secure financial future.
