Fixed-income is the asset class that includes all types of debt securities, most notably bonds. All types of bonds are sensitive to changes in interest rates, although some more so than others, and government bonds in particular.

Here’s how it works:  Say you invest $1000 in a newly issued bond that promises 4% interest. The following week, rates suddenly increase by 1%. Now, new bonds are offering 5% interest.  You could hold your bond to maturity and receive what you paid for it, plus the regular interest payments of 4%. But, if you want to sell, you’ll have to adjust your selling price downward. By reducing the market value of the bond, the“yield” automatically rises, bringing the bond’s rate of return in line with the newer issues that pay higher interest.

With any income generating investment, whether stocks or bonds, it is important to understand this notion of “yield”which is distinct from income. Bonds generate regular income in the form of interest payments. The amount of interest payable is fixed at the time the bond is issued and is known as the coupon rate. Yield refers to the total rate of return that an investor can expect to receive from their investment.

Government bonds are highly sensitive to changes in interest rates. So if the yield on a government bond is different from the coupon rate, it is because rates have either risen or fallen since the bond was issued. Bond prices always move in opposite direction with yield. Consider the illustration below…

As long as interest rates are rising, bond prices will fall in commensurate fashion. And in a rising interest rate environment such as we have today, bonds are understandably less attractive as an investment. But, that does not mean investors should now avoid bonds altogether. Fixed income can always play an important role in any investment portfolio, providing regular income, as well as diversification. Although both stocks and bonds have performed poorly in 2018, generally speaking, it is rare to see such an occurrence. Most importantly, bonds will never fall in value as precipitously as stocks or other equity investments can do. And when the stock markets are caught in the grip of a serious downturn, chances are that bonds will benefit from an upward surge in price.