Fixed income investing — guide to bonds
Understand fixed income investing with bonds, yields, duration and credit risk to build a diversified, income-focused portfolio.
What is a bond?
A bond is an investment that represents a loan from an investor to a government, company, or other issuer. In return, the issuer agrees to pay regular interest (coupons) and repay the original investment (principal or face value) at a fixed date in the future.
Bonds sit at the core of fixed income investing because they provide a relatively predictable income stream and tend to be less volatile than equities, helping preserve capital and diversify portfolios.
The interest a bond pays depends on economic conditions, the length of the loan (maturity), and the creditworthiness of the issuer.
What is fixed income investing?
Fixed income investing involves allocating capital to assets that pay regular, generally predictable income, usually via interest. The asset class is dominated by government and corporate bonds, as well as other securities designed to deliver stable cash flows over time. Investors use fixed income to balance equity holdings, temper volatility, and support consistent performance, particularly during periods of market uncertainty.
What is bond yield?
Bond yield is the annualised return an investor can expect from a bond, reflecting both coupon income and the bond’s current market price. As prices change, yields move inversely: when prices fall, yields rise, and when prices rise, yields fall. Yield helps investors compare bonds with different coupons, maturities, and prices.
How do bonds generate income?
Bonds generate income primarily through periodic coupon payments. Investors can also realise gains or losses from price movements: selling a bond above the purchase price produces a capital gain, while selling below results in a loss. Total return combines coupon income and price change.
How does bond pricing work?
Because most bonds pay fixed coupons, their prices adjust to remain competitive with new issues at current interest rates. If market rates rise, existing lower-coupon bonds become less attractive and their prices fall; if rates decline, existing bonds become more valuable and prices rise. This ensures yields align with prevailing conditions.
Why do bond prices fall when interest rates rise?
When interest rates rise, new bonds offer higher coupons. To offer a comparable yield, existing bonds with lower coupons must trade at lower prices. This inverse relationship between bond prices and yields is a fundamental feature of fixed income markets.
What is duration in bonds?
Duration measures a bond’s sensitivity to changes in interest rates and is expressed in years. A higher duration indicates greater price movement for a given rate change. Investors expecting falling rates may favor longer duration for potential price gains, while those concerned about rising rates often prefer shorter duration to reduce interest rate risk.
What impacts bond returns?
Bond returns are driven by interest rates (influencing prices and yields), credit conditions (the issuer’s ability to pay), and inflation (which affects the real value of future payments). Broader economic growth, central bank policy, and market sentiment shape these drivers and, in turn, fixed income performance.
What are high-yield bonds?
High-yield bonds are issued by companies with lower credit ratings. To compensate for higher default risk, they offer higher yields. These bonds can provide attractive income but are typically more sensitive to economic cycles and shifts in investor confidence.
Investment grade vs high-yield bonds
Investment grade bonds come from issuers with stronger financial profiles and lower perceived risk, typically offering lower yields. High-yield (sub-investment grade) bonds come from weaker credit profiles and offer higher potential returns to compensate for increased risk. This distinction shapes portfolio income and risk.
What is credit risk in bonds?
Credit risk is the possibility an issuer fails to pay interest or repay principal. Credit rating agencies assess this risk and assign ratings. Higher-rated bonds are generally more secure but offer lower yields; lower-rated bonds carry greater risk and potentially higher returns. Managing credit risk is central to fixed income investing.
What is inflation risk in fixed income?
Inflation risk is the potential for rising prices to erode the real (inflation-adjusted) value of coupon payments and principal. Fixed coupons are most exposed. Inflation-linked bonds can help mitigate this by adjusting payments with inflation, and duration management can reduce sensitivity to inflation-driven rate moves.
What is a fixed income portfolio and a diversified bond portfolio?
A fixed income portfolio is a collection of income-paying securities—primarily bonds—designed to deliver steady cash flows and manage risk. A diversified bond portfolio spreads exposure across issuers (government and corporate), sectors, regions, credit qualities (investment grade and high yield), and maturities/durations to reduce reliance on any single driver of returns and to balance income with capital preservation.