Dear Nancy Woods,
I hope you can help. I'm looking for someone who can explain the differences between fixed income funds and equity funds. Why are fixed income funds called what they are? There is not always an income component, let alone a "fixed income" component. The only thing "fixed" about fixed income products are the losses when markets go up.
The losses certainly are fixed. But where is the "income" part? Equities are somewhat understandable. When the market goes up, equities usually go up, and when the market goes down your value in your equities goes down. So, why do most advisers try to tell the client that they should have a "balance" of these two products?
Signed Neil
Dear Neil,
Let me start by explaining to you that "fixed income" instruments are debt of the issuing company. The investment has the backing of the company to pay the face value back to the shareholder upon some future maturity or call date. This applies to instruments such as bonds, debentures, preferred shares, etc. They are a means for the company to borrow money. In turn, they pay an income that is deemed as either interest or dividend.
Stocks or equities represent part ownership of a company. They are an investment by the shareholder that does not guarantee any income, fixed or otherwise.
In comparison, the fixed income instruments represent a higher security of principle and some kind of income. They are as a result interest rate sensitive. The yield is what determines the price.
Remember that everything works on supply and demand. The higher the demand, the higher the price. The higher the price, the lower the yield.
There is a balance correlation that exists between fixed income products and equity markets. When there is fear in the equity markets (and markets go down), investors "flee" to the safety of fixed income investments. That increases the demand of fixed income and values go up.
As you have noted, when markets go up, fixed income suffers price decreases and values go down.
As advisers we suggest a balance of these two classifications because most investors should have a portion of their portfolios that are "safe and secure." This is usually increasingly important as one ages and time frame of investing decreases. It is also important that you have an appropriate mix for your tolerance to risk and volatility.
Fixed income funds invest in those debt instruments and equity funds in shares. You can get both together in a balanced fund or do it yourself with individual holdings. They can be individual bonds, stocks or exchange traded funds (ETFs).
Nancy Woods, CIM, FCSI, is an associate portfolio manager and investment adviser with RBC Dominion Securities Inc. To ask her a question, send an e-mail to asknancy@rbc.com or visit her web site at nancywoods.com
READ MORE FROM OUR ASK AN ADVISER SERIES HERE
Nancy Woods