Understanding Fixed Income Yield

Investors who own shares of fixed income or bond mutual funds* do so for their relative safety compared to equities and for an expected rate of return, or yield. Because economic conditions affect yield, it can vary from one market cycle to the next. Here’s what you need to know if you are or will soon become an income investor.

The Certainties

When you buy U.S. Treasury securities directly, their rates are guaranteed by the full faith and financial strength of the United States government as long as you hold them until maturity. Other types of fixed income securities will also pay you a predetermined rate of return when you hold them until maturity, although lacking the ironclad guarantee of Treasury securities.

Just as with equities, the higher return promised by issuers of bonds, bills and notes, the more risk buyers will assume. In this case, it’s interest rate risk. This holds true whether you buy bonds issued by county and state entities, or you buy those issued by corporations.

The Misconceptions

Securities with longer maturity dates typically offer higher rates of return, but not always. In times of short-term economic uncertainty, two things can happen. One, the demand for certainty — such as in 10-year U.S. Treasury bonds — becomes greater, pushing yields down. Meanwhile, economic uncertainty can push the yield on two-year bills up. When short-term yield surpasses long-term yield, you have an inverted yield curve. This curve will right itself as economic certainty returns.

Remember that while direct ownership of Treasury securities offers certain guarantees, the same doesn’t hold true for mutual funds that include them.

*Investors should consider the investment objectives, risks and charges and expenses of the fund carefully before investing. Contact the issuing firm to obtain a prospectus which should be read carefully before investing or sending money. Because mutual fund values fluctuate, redeemed shares may be worth more or less than their original value. Past performance won’t guarantee future results. An investment in mutual funds may result in the loss of principal.