Fixed income instruments are products that offer predictable, or fixed rate of returns. In India, these typically include company bonds, fixed deposits and government schemes.

You should go in for such products if you need a certain, predictable stream of income, as against shares where returns are uncertain. Besides being predictable, such instruments are also low in risk. They are thus better investment options for people whose risk tolerance is low.

Time is another important parameter. Equity shares are best recommended as a long-term (more than five years) option. Use money you are likely to need in the short term to invest in fixed-income instruments.

Dos and don’ts
Before you decide to invest in fixed-income instruments, evaluate your needs from three key perspectives - risk, returns and liquidity. Match the investment options with your financial needs.

Credit risk
What if the issuer fails to pay what he owes you (principal, interest)? Evaluate credit ratings assigned by rating agencies like CRISIL, ICRA and CARE to find corporate bonds/ fixed deposits that match your risk tolerance level.

Diversify
Diversification across issuers of fixed-income instruments is a recommended approach to reducing credit risk

Returns
Return calculations should consider effective yield, interest rate expectations and taxes.

Calculate post-tax effective yield (IRR or Internal Rate of Return) for each instrument for comparison. 

Take inflation into account. If interest rates increase during your investment period, you will not benefit from investing. So, if you expect interest rates to increase, invest only in short-term instruments, and vice versa.

While calculating your interest yield remember to include post-tax interest receipts. For investors in high-tax brackets, tax-free government bonds/ schemes might be more attractive.

Mutual funds are also good fixed income instruments due to zero tax liability on income.

Liquidity
Fixed-income instruments are normally not liquid, since the secondary market for these instruments has not yet developed in India. Before investing, be sure to carefully evaluate potential liquidity, exit route and penalties of the instrument.