What is fixed income? Why invest in fixed income? How should I invest in bonds? What type of bonds should I use? What are bond funds? Should I invest in bond mutual funds?
We believe investing revolves around the intertwined concepts of risk and return. The more risk you are willing to take, the more return you should expect. When investing in fixed income, two main concerns drive the risk return tradeoff: maturity and credit. As the maturity of a bond increases, its interest rate risk increases and so should its return. When the credit quality of a bond declines, its default risk increases and so should its expected return. In practice however, the relationship between risk and return for bonds has not been linear.
In essence, investing in bonds is simply lending a company your money for a specific period in return for them making periodic interest payments to you and then returning your principal at some predetermined “maturity date.” For longer maturity dates, investors demand a higher coupon rate because of the increased chance that the company could go bankrupt before it can pay back the principal. Longer maturities do have increased annual return expectations, but the additional return comes at the steep price of much higher volatility.