Mastering Fixed Income Trinity: Balancing Income, Duration and Liquidity

Investing isn't about avoiding trade-offs—it's about making informed and strategic choices

- Bhupendra Meel

Fixed income investments have traditionally been a cornerstone for Indian investors, offering stability and diversification in volatile markets. Building a robust portfolio involves balancing income, duration, and liquidity. The elements, collectively known as the "fixed income trinity," are essential to bond investing but involve trade-offs. Much like the "impossible trinity" in economics, the fixed income trinity says simultaneously optimizing all three elements is not feasible. Investors must prioritize two, compromising with the third. The three key aspects:

Income: Interest earned on bonds. Lower-rated issuers typically offer higher yields to compensate for added risks such as the potential for default and lower liquidity.

Duration: Measures bond's response to interest rate changes, helping investors assess price movement with rate fluctuations.

Liquidity: Ease with which trading can be done without significantly affecting price. High-rated bonds have better liquidity.

Investors cannot fully optimize income, duration, and liquidity simultaneously. Here's how the trade-offs play out: