If Equity is the "Offense" of a football team (scoring goals), then Fixed Income is the "Defense" (preventing goals). And Alternative Investments are the "Special Teams"—brought in for specific situations like inflation or currency crises.
Many retail investors find bonds boring. They don't double in price overnight. But boring is beautiful. In 2008, when stocks fell 50%, high-quality government bonds rose in value. A portfolio without fixed income is a car without an airbag—fine until you hit a wall.
Part 1: Understanding Fixed Income (Bonds)
A bond is simply a loan. Instead of a bank lending to a company, you lend to the company (or government). In return, they promise to pay you regular interest (Coupons) and return your original money (Principal) at a specific date (Maturity).
The Golden Rule: Price vs. Yield
The most difficult concept for beginners is the inverse relationship between interest rates and bond prices. When Interest Rates rise, Bond Prices fall. Why?
Imagine you own an old bond paying 3% interest. Suddenly, the Central Bank raises rates, and new bonds are issued paying 5%. No one wants to buy your old 3% bond anymore because it pays less. To sell it, you must lower its price (sell it at a discount) until its effective yield matches the new 5% rate.
As Yields (Interest Rates) go up, the Price of existing bonds must come down.
Types of Bond Risks
Bonds are safer than stocks, but not risk-free. You face two main enemies:
- Credit Risk (Default Risk): The borrower might go bankrupt.
Mitigation: Buy Government bonds (Sovereign Guarantee) or highly-rated Corporate bonds (AAA). - Duration Risk (Interest Rate Risk): If rates rise, your bond value drops. Long-term bonds (30-year) are much more sensitive to this than short-term bonds (1-year).
Mitigation: Match the bond maturity to when you need the money.
The Yield Curve
Normally, long-term bonds pay higher interest than short-term bonds to compensate for locking your money away. This creates an upward-sloping "Yield Curve." Occasionally, the curve "Inverts" (short-term rates are higher than long-term). An Inverted Yield Curve is one of the most reliable predictors of an upcoming recession.
Part 2: Alternative Investments (Alts)
Alternatives are assets that do not fall into the traditional Stocks, Bonds, or Cash categories. Their primary role in a portfolio is Diversification—they often zig when the market zags.
Gold
The ultimate store of value. It generates no cash flow (no dividends), but it cannot be printed by central banks.
Real Estate
Tangible property. Benefits from leverage (mortgages) and provides regular rental income.
Crypto
Digital assets secured by cryptography. Highly volatile and speculative, but potential for massive growth.
Real Estate Investment Trusts (REITs)
Physical real estate is illiquid (hard to sell). REITs solve this. They are companies that own office buildings, malls, or data centers, and trade on the stock exchange like regular shares. They are required by law to pay out 90% of their taxable income as dividends, making them excellent income generators.
The Illiquidity Premium
Sometimes, being unable to sell is a feature, not a bug. If you own a house, you don't check its price every day. You ride out market dips because you have to. This forced discipline often leads to better long-term returns compared to stocks, which are too easy to panic-sell.
Summary
A professional portfolio is not just a collection of stocks. It uses Bonds to anchor the portfolio against recessions and Alternatives like Gold and Real Estate to protect against inflation and currency debasement. By combining these assets, you create an "All-Weather" portfolio capable of surviving any economic climate.
But building the portfolio is only half the battle. Maintaining it is the other half. In the next module, we will discuss the critical discipline of maintenance: Portfolio Rebalancing.