Safety and Return with Fixed Income

While the main goal of fixed income investments is to seek a predictable and reliable form of income, a fixed rate of interest actually, one of the main reasons why people purchase fixed income investments is to look to significantly reduce the risk involved in investing.

If you invest in something that provides a certain amount of interest then this of course limits the amount of money you can make from these investments to this certain amount, which is the price you pay for this investment security.

You may still lose your principal though, if the bond issuer defaults, if the company goes out of business, or if the bank becomes insolvent, and this default risk does play a substantial role in fixing the interest rates that the security pays out.

How much safety an investment has and how much return one can achieve with them are very correlated, at least in terms of the perceived risks. We can never predict the future of course, and we are limited to forecasting it, and the risks that are priced into these investments are based upon these forecasts, the market perception of what these risks may be manifest in the risk premium that gets paid out to them.

The idea though with all fixed income investments is to seek reliability of returns, which includes both the amount and the likelihood of it being paid out and one’s principal not being lost. So this class of investments is already disposed toward that, where we then select among various investments in the class to achieve our desired balance between risk and return.

In doing this, we must seek to define what level of safety we require, and safety should always be the primary concern, much like managing risk with any investment needs to be primary. If and only if the investment is deemed safe enough for our purposes should we even be looking at achieving our goals of return, because otherwise we would not be pursuing these returns safely enough.