What are the potential benefits of fixed income?
Depending on your financial goals, fixed income investments can offer many potential benefits, including:
1. Diversification from stock market risk - Fixed income is broadly understood to carry lower risk than stocks. This is because fixed income assets are generally less sensitive to macroeconomic risks, such as economic downturns and geopolitical events.
2. Capital preservation - Capital preservation means protecting the absolute value of your investment via assets that have a stated objective of return of principal. Investors who are closer to retirement may rely on their investments to provide income. Because fixed income typically carries less risk, these assets can be a good choice for investors who have less time to recoup losses.
3. Income generation - Fixed income investments can help you generate a steady source of income. Investors receive a fixed amount of income at regular intervals in the form of coupon payments on their bond holdings.
4. Total return - Some fixed income assets offer the potential to generate attractive returns. Investors can seek higher returns by assuming more credit risk or interest rate risk.
Why are interest rates as high as they are?
Unprecedented inflation levels following the COVID-19 pandemic spurred a historically aggressive Fed & Bank of Canada tightening cycle in 2022. Eight consecutive rate hikes led to rates increasing from 0–.25% to 4.25–4.50% currently. Looking ahead, we believe the peak in U.S. & Canadian rates is behind us, but we anticipate that inflation will be more persistent than the market is currently pricing. Thus, the Federal Reserve (Fed) and Bank of Canada (BoC) will likely keep the fed funds rate elevated throughout 2023, while economic growth remains positive but slow. We are still a long way from the Fed’s target inflation rate of 2%.
How do higher interest rates affect fixed income products?
Put simply, rising interest rates historically cause yields on fixed income products to go up. Because of the current high interest rate environment we are in, there are very attractive yields in the investment-grade corporate bond space, bank-backed GICs and many other fixed income products.
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