Guide to Laddered Investing with Fixed Income
Key Takeaways
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Fixed-income investments provide predictable interest payments and return your principal at maturity.
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Fixed-income investments reduce risk, preserve capital, and provide stable, passive income for your portfolio.
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Short Notes stand out as a fixed income investment option with higher yields, shorter terms, and the ability to diversify with private real estate.
Diversification is the foundation of a strong financial portfolio, and investments that deliver fixed-income returns are an important element of a sound financial strategy. We'll explore fixed-income investments, understanding what they are, how they work, the different options, and how to get started.
What is Fixed Income?
A fixed-income investment provides returns through regular, fixed-interest payments, and the initial investment is returned at maturity. They are different from variable-income securities, where payments can change because they are based on factors such as short-term interest rates.
Fixed-income investments are perfect for investors seeking to preserve capital while earning predictable and known income. Fixed-income investments can help add stability and lower risk to a portfolio when other asset classes, like stocks, face market volatility.
Understanding Fixed Income
When asked, "What is a fixed-income investment?", the most common answer is bonds, which are essentially loans to the government or corporations. The bond represents the borrower's promise to pay the loan back, with interest, by a specific date. As a debt instrument, the bond and other fixed-income investments pay out a fixed amount of interest. The frequency of those payments will vary depending on the type, but the return amount is predictable.
You may hear about coupon payments in discussions about bonds because, historically, a bond was a physical piece of paper with coupons. The physical possession of the bond was proof of ownership, and coupons for each scheduled interest payment were attached to it. Bond owners would detach each coupon on its due date and present it to a bank to be cashed.
Historically, bonds have been considered among the best fixed-income investments, but they aren't entirely risk-free. Bonds from a government or corporation with a higher credit risk will compensate by paying higher interest rates.
Different Types of Fixed Income
While bonds are the most common type of fixed-income investment, there are several other different types to consider. These include:
- Government bonds - Governments require methods to raise the money needed to finance their spending, and they issue bonds. These bonds are considered to be quite safe because a national government backs them. The U.S. Treasury bonds are popular with investors who seek stable, low-risk investments.
- Corporate bonds - The types of corporate bonds vary, as do the price and interest rate, which depend on the company's financial stability and creditworthiness. Bonds with higher credit ratings typically pay lower coupon rates.
- Municipal bonds - These are similar to Treasury bonds, but instead of being backed by the federal government, they are backed by a state, municipality, or county government. They aim to raise capital for local expenditures, and municipal bonds often come with tax-free benefits.
- Certificates of deposits (CDs) - Offered by banks and credit unions, CDs are considered very safe and are typically insured by the Federal Deposit Insurance Corporation (FDIC) up to a certain limit.
- Agency bonds - Agency bonds are generally considered safer than corporate bonds. They tend to pay higher returns than Treasury bonds. Agency bonds are issued by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac and are liked by investors who seek higher returns without undue risk.
- Short Notes - When you invest in a Connect Invest Short Note, the investment is used to help fund a pool of commercial and residential real estate loans across acquisition, development, and construction phases. Connect Invest's model reduces investor risk by exclusively funding first-position, collateral-backed real estate loans, so in the case of a default, Connect Invest is first in line for repayment. Short Notes offer attractive interest yields and investment terms, offering up to 9% annualized interest for a 24-month note. Short Notes investments can be "stacked" or "laddered," meaning that you can invest in multiple Short Notes simultaneously, maximizing your earned interest and monthly passive income.
Diversifying Your Portfolio with Fixed Income
We've said it before, and we'll say it again - diversification balances and strengthens a portfolio. A portfolio with investments across different asset classes can weather any storms from market volatility. For example, when the value of stocks takes a downturn, a diversified portfolio remains protected by lower-risk investments like bonds and Short Notes.
Some of the benefits of diversifying an investment portfolio with fixed income are:
- Passive income - The primary benefit of a fixed-income investment is that the investor earns regular interest payments. This is particularly helpful for retirees who rely on their investments to meet their living expenses, and predictable income makes it easier to plan and budget.
- Capital preservation - Due to their lowered risk, fixed-income investments preserve capital. Investors know that their initial investment will be returned at maturity and that it's protected from market volatility.
- Diversification - A fixed-income investment diversifies a portfolio and protects it from market downturns because it performs differently from stocks.
- Less volatility - Risk-averse investors are attracted to fixed-income investments because of their low volatility.
What is Laddering and Fixed Income Laddering?
A popular financial strategy called laddering involves investors purchasing different financial instruments of the same type with staggered maturity dates. The goal is to create a steady income. It can be applied to various kinds of investments, such as bonds, CDs, and annuities.
Let's look at how this works. An investor can buy bonds that mature at 1, 2, 3, 4, and 5 years. The principal amount is reinvested in a new 5-year bond when the first bond matures. The process is repeated with each maturity, and you can visualize how the maturity length of the ladder is maintained. The other benefit is that interest rates will increase as newer bonds mature and are reinvested in longer-term bonds.
Advantages of Laddering Investments
Laddering investments is an effective method of managing interest rate risk. With staggered maturity dates, investors avoid getting locked into a single interest rate. The varied maturity dates smooth out the negative effects of those interest rate fluctuations.
If interest rates have risen when a bond matures, investors will benefit by reinvesting. Sometimes rates will fall, but the bonds at the end of the ladder will still likely have locked-in yields.
Another advantage of laddering investments is that investors can manage cash flow. The fixed-income payments are predictable, and investors can map out their coupon payments across the ladder.
Introducing Fixed Income Short Notes
Investor interest in Connect Invest's exclusive fixed-rated Short Notes offerings is rapidly gaining popularity. With their higher yields and shorter investment durations compared to most other fixed-income products, Short Notes stand out as an attractive possibility.
The priority of Connect Invest is accessibility and delivering above-average returns. Investors choose from three Short Note options: a 6-month note at 7.5%, a 12-month note at 8%, or a 24-month note at 9%, all offering annualized rates.
These Short Notes fund a carefully vetted, diverse portfolio of private real estate loans, all backed by collateral and first-position status. This means that in the unlikely event of borrower default, our loan originator is first in line to recover funds. Investor capital is allocated to a range of projects, including residential and commercial real estate, spanning acquisition, development, and construction phases.
Short Notes diversify a portfolio, and investors can count on monthly, fixed-rate payments.
Short Notes
Investors who structure a laddered portfolio with Short Notes may achieve more consistent returns over the long term. Over the period of your investment, Short Notes automatically earn interest and principal payments.
They offer attractive investment terms and annualized interest yields - 6 months (7.5% annualized interest), 12 months (8% annualized interest), and 24 months (9% annualized interest). The date the interest accrues each month depends on the day that you purchased your Note. Upon the maturity of your Short Note, you will be paid out your invested principal in full.
Let's take a look at an example. Imagine you have $20,000 to invest in equal portions in Short Notes using the laddered strategy over four years. To create a ladder with eight rungs, you would be investing $2,500 twice a year over a four-year term.
Each rung will have different maturities and corresponding annual interest rates, which will help to mitigate risk and act as a hedge. You can continue to reinvest each maturing portion and fixed income into the next rung. Laddered investments provide the flexibility to adjust your investing strategy as your objectives and needs change.
Closing Thoughts
Fixed-income investments are part of a diversified financial portfolio that provides regular and predictable fixed income and adds a lower-risk element that helps safeguard portfolios during market downturns.
Bonds, CDs, and Short Notes are perfect for risk-averse investors looking for reliable, fixed-rate income, and a laddered strategy can help them grow their wealth.