Building a strong investment portfolio is a lot like constructing a durable building; it requires a solid foundation. In the world of finance, fixed income often serves as that essential base. It provides the stability and structure needed to support your more growth-oriented assets. Creating this foundation requires a clear plan. A comprehensive fixed income strategy acts as your architectural blueprint, guiding you on which materials (securities) to use, how to assemble them (diversification), and how to ensure the structure can withstand pressure (risk management). We will cover everything from the basic building blocks to the advanced techniques used to fortify your financial future.
Key Takeaways
- Prioritize Stability and Income: Use fixed income investments as the anchor of your portfolio. Their main purpose is to preserve your capital and generate a predictable stream of cash flow, providing a crucial balance to more volatile growth assets.
- Actively Manage Key Risks: Success in fixed income requires managing its two primary risks: interest rate changes that affect bond prices and the creditworthiness of the issuer. Diversifying across different bond types, maturities, and sectors is essential for building a resilient portfolio.
- Build and Monitor Your Strategy with Intention: A strong portfolio starts with clear financial goals. Analyze investments using metrics like yield and duration, and regularly review your holdings to ensure they remain aligned with your objectives and the broader economic outlook.
What Is a Fixed Income Strategy?
A fixed income strategy is an investment approach centered on preserving your capital while generating a predictable stream of income. At its core, you are lending money to an entity, such as a government or a corporation. In exchange for your loan, they agree to pay you regular interest over a set period. When that time is up, they return your original investment, known as the principal. This method provides a steady, or “fixed,” income, which is where the name comes from. It’s a fundamental part of a well-rounded portfolio, offering a stable counterweight to the volatility you might see in the stock market. By understanding the different components and management styles, you can build a fixed income strategy that aligns with your financial goals.
Breaking Down the Core Components
The world of fixed income is diverse, but it’s built on a few key types of securities. The most common are bonds. You’ll find various kinds, including government bonds like Treasury bills and notes, municipal bonds from state and local governments, and corporate bonds issued by companies. You can invest in these assets in a few different ways. Some people prefer to purchase individual bonds directly, while others choose mutual funds or exchange-traded funds (ETFs) that hold a collection of different bonds. Each approach has its own set of considerations, but they all serve the same core purpose of providing steady interest payments.
The Role of Fixed Income in Your Portfolio
So, why should you make fixed income a part of your overall investment plan? Its main role is to add stability and diversification. While stocks can offer higher growth potential, they also come with more risk and price fluctuations. Fixed income investments tend to be less volatile, which helps cushion your portfolio during market downturns. They also provide a reliable source of income, which can be especially valuable if you need consistent cash flow. Furthermore, these investments are key for capital preservation. In the event a company faces bankruptcy, bondholders are typically paid back before stockholders, offering an added layer of security for your initial investment.
Choosing Your Management Style: Active vs. Passive
Once you decide to include fixed income in your portfolio, you’ll need to think about how you want it managed. The two main approaches are active and passive. A passive strategy usually involves tracking a specific bond index, aiming to match its performance with minimal trading. On the other hand, an active management strategy involves a portfolio manager making specific decisions to outperform the market. This often combines broad economic analysis with in-depth research on individual bonds. While a passive approach is often simpler and has lower costs, an active strategy gives you the potential to achieve higher returns, especially if you’re comfortable with a bit more risk.
Your Guide to Fixed Income Securities
Fixed income isn’t a one-size-fits-all category. The market is filled with different types of securities, each with its own characteristics, risk profile, and potential role in your portfolio. Understanding these options is the first step to building a strategy that aligns with your financial goals. Let’s look at some of the most common types you’ll encounter.
Government Bonds
When you buy a government bond, you are lending money to a country’s government. In return for your loan, the government promises to pay you periodic interest payments—often called coupon payments—and return your initial investment, or principal, at a set future date. Because they are backed by the full faith and credit of the government, securities like U.S. Treasury bonds are widely considered to be among the safest investments available. They serve as a foundational element in many conservative portfolios, providing stability and a predictable income stream.
Corporate Bonds
Corporate bonds are similar, but instead of lending to a government, you’re lending to a company. Businesses issue bonds to raise capital for things like expansion, research, or refinancing debt. The interest rate a company offers is directly tied to its perceived financial health. Companies with strong financials and high credit ratings from agencies like Moody’s or S&P are considered lower risk and typically offer lower interest rates. Conversely, companies with weaker financials must offer higher rates to attract investors, compensating them for taking on more risk. This creates a wide spectrum of opportunities, from stable, investment-grade bonds to higher-yielding debt.
Municipal Bonds
Often called “munis,” these are debt securities issued by state, city, or other local governments to fund public projects like building schools, highways, or sewer systems. What makes municipal bonds so attractive to many investors is their tax-exempt status. The interest you earn is typically exempt from federal income tax. If you buy a muni issued by your home state, it may also be exempt from state and local taxes. This tax advantage can make the effective yield on a municipal bond much more attractive than that of a taxable bond, especially for individuals in higher tax brackets.
Fixed Income ETFs and Mutual Funds
If you prefer a more diversified approach without picking individual bonds, fixed income ETFs and mutual funds are excellent options. These funds pool money from many investors to buy a broad portfolio of bonds. This instantly gives you diversification across dozens or even hundreds of different issuers. Mutual funds are typically managed by professionals who actively select the bonds for the portfolio. Exchange-Traded Funds (ETFs), on the other hand, often track a specific bond index and trade on an exchange just like a stock, which can sometimes result in lower fees.
Structured Credit Options
Beyond the traditional categories, you’ll find more complex instruments like structured credit. These are specialized securities created by pooling various types of debt—like commercial mortgages, auto loans, or private loans—and then selling shares of that pool to investors. These products can offer unique risk-return profiles that aren’t always available in the broader bond market. As Guggenheim Investments notes, actively managed portfolios that include structured credit can uncover attractive returns. However, due to their complexity, they are often best suited for institutional or high-net-worth clients and typically require professional management to analyze effectively.
What Are the Risks in Fixed Income?
While fixed income investments are often seen as a stable part of a portfolio, they aren’t without risk. Understanding these potential challenges is the first step toward building a resilient strategy that aligns with your financial goals. From shifts in the broader economy to the specific financial health of a bond issuer, several factors can influence the performance of your holdings. By familiarizing yourself with these risks, you can make more informed decisions, select appropriate securities, and better position your portfolio to weather market changes. Let’s walk through the primary risks you’ll encounter in the fixed income space.
How Interest Rates Affect Your Bonds
One of the most fundamental risks in bond investing is interest rate risk. Think of it this way: if you buy a bond with a fixed interest rate and then market interest rates go up, newly issued bonds will offer more attractive payments. This makes your older, lower-rate bond less desirable. Should you need to sell your bond before its maturity date, you may have to sell it for less than you originally paid to compete with the newer, higher-paying options. This inverse relationship between interest rates and bond prices is a key concept for every fixed income investor to understand.
Assessing Credit and Default Risk
Credit risk, also known as default risk, is the possibility that the bond issuer won’t be able to make its promised interest payments or repay the principal amount at maturity. This risk varies significantly depending on who issues the bond. Government bonds, for example, typically have very low credit risk. Corporate bonds, on the other hand, require a closer look at the company’s financial stability. To help investors, credit rating agencies assess and grade bonds. Securities with lower ratings, sometimes called “junk bonds,” offer higher yields to compensate for their increased risk of default.
The Impact of Inflation
Inflation can quietly diminish the value of your returns. Because most bonds pay a fixed interest rate, high inflation can erode the purchasing power of those payments. If your bond yields 3% but inflation is running at 4%, your real return is actually negative. You’re losing buying power over time. This is a critical consideration for long-term investors who rely on fixed income for a steady stream of cash flow. Some investments, like Treasury Inflation-Protected Securities (TIPS), are structured specifically to help protect against inflation by adjusting their principal value as inflation changes.
Factoring in Liquidity
Liquidity risk is the chance that you won’t be able to sell your bond quickly at a fair market price. While many government and high-grade corporate bonds are highly liquid, some corners of the market are not. Certain municipal bonds or bonds from smaller corporations may have fewer potential buyers, making them harder to offload without accepting a significant discount. Major market events or economic uncertainty can also reduce liquidity across the board, making it difficult to sell even typically stable investments. Understanding the liquidity of your holdings is essential, especially if you anticipate needing to access your capital before a bond matures.
How Market Conditions Play a Role
The broader economic environment has a major influence on fixed income investments. Factors like economic growth, unemployment rates, and central bank policies all affect interest rates and investor sentiment. For instance, expectations of strong economic growth might lead to rising interest rates, which could negatively impact existing bond prices. Conversely, a slowing economy might prompt the central bank to lower rates, making existing bonds more valuable. Staying aware of current economic conditions and forecasts helps you anticipate potential shifts in the market and adjust your strategy accordingly.
Building Your Fixed Income Portfolio
Constructing a fixed income portfolio is a thoughtful process that goes beyond simply buying a few bonds. It’s about creating a balanced, resilient collection of assets that aligns with your specific financial objectives. A well-built portfolio can provide a steady stream of income, preserve your capital, and offer stability during market volatility. The key is to be intentional with your choices, from the types of securities you select to how they fit within your broader financial picture. Let’s walk through the essential steps to build a portfolio that works for you.
Decide on Your Asset Allocation
Your first step is to determine your asset allocation. This means deciding on the right mix of fixed income securities based on your risk tolerance and return expectations. The fixed income market is incredibly diverse, offering everything from low-risk government bonds to higher-yield corporate debt. A well-optimized portfolio often includes a combination of investment styles to meet specific goals. For instance, you might balance the safety of U.S. Treasuries with the growth potential of investment-grade corporate bonds to create a portfolio tailored to your financial needs.
Define Your Income Needs
Why are you investing in fixed income? The answer to this question will shape your entire strategy. If you’re approaching retirement, your primary goal might be to generate a predictable income stream to cover living expenses. In this case, you’d likely focus on high-quality bonds with regular coupon payments. On the other hand, if you’re further from retirement, you might use fixed income to preserve capital and add a layer of stability to a growth-oriented portfolio. Understanding your income requirements helps you select securities with the right maturities and yields.
Plan for Tax Efficiency
Not all investment returns are treated equally by the IRS. A smart fixed income strategy includes planning for tax efficiency to help you keep more of what you earn. Certain types of bonds, like municipal bonds, offer interest payments that are often exempt from federal, and sometimes state and local, taxes. For investors in higher tax brackets, these tax-advantaged securities can be an especially powerful tool. By carefully selecting your investments, you can build a portfolio that not only generates income but also minimizes your tax burden.
Integrating ESG Factors
Investing based on your values is becoming a significant part of modern portfolio construction. Many investors now look to integrate Environmental, Social, and Governance (ESG) factors into their fixed income strategies. This approach allows you to support companies and projects that align with your principles, whether that’s clean energy, social equity, or transparent corporate governance. By applying an impact lens to your investments, you can pursue financial returns while contributing to positive change, adding another layer of purpose to your portfolio.
Diversify Your Holdings
Diversification is a fundamental principle of sound investing, and it’s just as important within your fixed income allocation. Holding a variety of bonds across different sectors, credit qualities, and maturities can help you manage risk. For example, government bonds tend to perform well when the economy slows, while corporate bonds may offer more potential when the economy is strong. A balanced portfolio that includes a mix of these assets can help smooth out returns and protect against unexpected market shifts, making your portfolio more resilient over the long term.
How to Analyze Fixed Income Investments
Once you understand the types of securities available, the next step is to evaluate individual investments. Analyzing fixed income requires a different lens than analyzing stocks. Instead of focusing on growth potential, your analysis will center on an issuer’s ability to repay its debt and how market forces might affect the value of your investment. By looking at a few key metrics, you can get a clear picture of an investment’s risk and potential return, helping you make choices that align with your financial goals.
Measuring Yield
Measuring yield is the first step in understanding the return you can expect from a fixed income investment. In simple terms, yield is the income a bond generates relative to its price. While a bond’s coupon rate is fixed, its yield can change as its market price fluctuates. Security analysis in fixed income has traditionally focused on financial metrics like company earnings, balance sheet strength, and cash flow to determine an issuer’s stability. A higher yield often signals higher risk, so it’s important to look at yield in the context of the issuer’s financial health and overall market conditions.
Analyzing Duration
Duration is a key metric that helps you understand how sensitive a bond’s price is to changes in interest rates. It’s not just about the bond’s maturity date; it measures how much the price of a bond is likely to fluctuate when rates move. A bond with a longer duration will be more sensitive to interest rate shifts—its price will fall more when rates rise and increase more when rates fall. Understanding a bond’s duration helps you manage interest rate risk within your portfolio and make strategic decisions based on your outlook for the economy.
What Credit Ratings Mean
Credit ratings give you a straightforward way to measure the credit risk of a fixed income security. Agencies like Moody’s, S&P, and Fitch analyze an issuer’s financial health to determine its ability to meet its debt obligations. The higher the credit rating, the greater the likelihood that the issuer will make its interest payments and repay the principal on time. These ratings provide a standardized framework for comparing the relative risk of different bonds. While a high rating isn’t a perfect predictor, it’s an essential tool for assessing the fundamental strength of an investment.
A Look at Default Rates
Default rates are a critical factor in assessing the risk tied to fixed income investments. A default occurs when a bond issuer fails to make a scheduled interest or principal payment. By looking at historical default rates for different types of bonds (like investment-grade versus high-yield), you can get a better sense of the potential risks involved. This historical data helps you gauge how certain sectors or credit qualities have performed during different economic cycles. Monitoring these trends is a practical way to inform your risk management and asset allocation decisions.
Key Market Indicators to Watch
Beyond individual securities, it’s important to watch key macroeconomic indicators that influence the entire fixed income market. Factors like GDP growth, inflation, and central bank interest rate policies can have a significant impact on bond prices and yields. For example, rising inflation can erode the real return of your investments, while changes in interest rates directly affect bond values. Staying informed on these trends helps you manage risk and position your portfolio for changing market conditions. You can find expert analysis on these topics in our firm’s Research & Insights.
Explore Advanced Fixed Income Strategies
Once you have a solid foundation, you can begin to incorporate more sophisticated techniques into your fixed income approach. These strategies are designed to give you more control over your portfolio’s risk and return profile, allowing you to adapt to changing market conditions and fine-tune your income stream. Think of these not as replacements for the core principles of fixed income investing, but as powerful tools to add to your toolkit. They require a deeper understanding of market dynamics, from interest rate movements to economic cycles. By exploring these methods, you can build a more resilient and responsive portfolio that aligns precisely with your financial objectives, whether that’s maximizing income, preserving capital, or finding a balance between the two. Let’s look at a few of the most effective advanced strategies.
Bond Laddering
Bond laddering is a classic strategy that helps smooth out the effects of interest rate fluctuations. Instead of investing a lump sum into a single bond, you divide the principal and buy several smaller bonds with staggered maturity dates. For example, you might buy bonds that mature in one, two, three, four, and five years. As each bond matures, you can either reinvest the principal into a new long-term bond at the end of the ladder or use the cash for income. This approach provides a steady stream of liquidity and helps you manage interest rate risk by avoiding the need to reinvest your entire portfolio when rates might be low.
Yield Curve Positioning
This strategy is more forward-looking and involves making investment decisions based on anticipated shifts in the yield curve. The yield curve plots the interest rates of bonds with equal credit quality but different maturity dates. Its shape—whether it’s steep, flat, or inverted—can offer clues about the market’s economic expectations. By analyzing these trends, you can position your portfolio to benefit from expected changes in interest rates. For instance, if you expect long-term rates to fall, you might invest in longer-maturity bonds to lock in higher yields and potentially see their prices appreciate.
Duration Management
Duration is a measure of a bond’s price sensitivity to a 1% change in interest rates. The longer a bond’s duration, the more its price will fluctuate when rates move. Duration management is the active process of adjusting your portfolio’s overall duration to align with your interest rate forecast. If you anticipate rates will rise (which causes bond prices to fall), you might shorten your portfolio’s duration to reduce its sensitivity. Conversely, if you expect rates to fall, you could lengthen the duration to increase potential price gains. This is a key way investors can proactively mitigate interest rate risk.
Sector Rotation
The fixed income market is made up of various sectors, including government bonds, corporate bonds, and municipal bonds, each with its own risk and return characteristics. Sector rotation involves shifting investments between these different areas based on where we are in the economic cycle. For example, during an economic expansion, corporate bonds might perform well as company profits grow. In a downturn, investors often prefer the relative safety of government bonds. By strategically rotating through sectors, you can position your portfolio to capitalize on broad economic trends and changing market sentiment.
Non-Traditional Approaches
For those looking beyond conventional bonds, non-traditional fixed income offers another layer of opportunity. These strategies involve investing in areas like asset-backed securities, structured credit, or private lending. While they can be more complex and may carry different types of risk, they can also provide higher yields and valuable diversification benefits since their performance is often not directly tied to the traditional bond or stock markets. These alternatives can be a powerful way to enhance returns and build a more diversified income portfolio, especially in a low-yield environment.
How to Manage and Monitor Your Portfolio
Building your fixed income portfolio is just the first step. The real work lies in managing and monitoring it over time. Markets shift, economic conditions change, and your own financial goals can evolve. Staying engaged with your portfolio helps you ensure it continues to work for you, aligning with your objectives for income generation and capital preservation. A proactive approach allows you to respond thoughtfully to market movements rather than reacting to them. It’s about maintaining discipline, managing risk, and spotting opportunities as they arise. Think of it as the ongoing maintenance that keeps your investment engine running smoothly and efficiently, helping you stay on course toward your long-term financial destination. This continuous process involves several key practices, from setting clear guidelines and managing risk to regularly reviewing your holdings and making strategic adjustments when necessary. By treating your portfolio as a dynamic entity rather than a static collection of assets, you empower yourself to adapt to new information and maintain control over your financial future.
Set Clear Investment Guidelines
Before you can effectively monitor your portfolio, you need to know what you’re measuring it against. Setting clear investment guidelines gives you a framework for making objective decisions. This means defining your goals, risk tolerance, and the specific metrics you’ll use to track performance. For instance, you might establish targets for income generation, credit quality, and duration. By creating your own set of rules, you can evaluate performance with clarity and avoid making emotional choices based on short-term market noise. Having clear benchmarks and guidelines is fundamental to disciplined investing and helps keep your strategy focused on what matters most to you.
Implement Risk Management
Managing risk in a fixed income portfolio is about more than just avoiding losses; it’s about understanding and controlling your exposure to different factors like interest rate changes and credit events. The fixed income market offers a wide array of tools to help with this. A well-rounded approach often involves using a combination of investment styles to optimize your portfolio within your specific risk budget. By diversifying across different types of bonds, maturities, and credit qualities, you can build a more resilient portfolio. This method helps ensure that a downturn in one area doesn’t disproportionately impact your overall returns, allowing for more customized solutions and strategies that can deliver on your target returns.
Review Your Portfolio Regularly
A fixed income portfolio isn’t something you can set and forget. Regular reviews—whether quarterly, semi-annually, or annually—are essential for keeping your investments aligned with your goals. These check-ins are your opportunity to assess performance, review your holdings, and confirm that your strategy is still appropriate for the current market environment. Economic policies change and market conditions can become turbulent. Consistent reviews help you get comfortable with these shifts while positioning portfolios to take advantage of opportunities that may arise from volatility. It’s a proactive step that keeps your strategy relevant and responsive.
Make Strategic Adjustments
Following a portfolio review, you may find that adjustments are needed. This isn’t about timing the market, but about making thoughtful, strategic changes to keep your portfolio on track. For example, you might need to rebalance back to your original asset allocation if certain holdings have outperformed others. In times of increased market volatility, many investors find themselves reassessing their guidelines and seeking advice on how to proceed. Making strategic adjustments could involve trimming exposure to a certain sector, extending or shortening your portfolio’s duration, or upgrading the credit quality of your holdings to better align with your risk tolerance and the economic outlook.
Analyze Your Performance
Analyzing your portfolio’s performance helps you understand what’s working and what isn’t. This goes beyond simply looking at the total return. A thorough analysis involves comparing your returns to relevant benchmarks, evaluating the income generated, and assessing the level of risk you took to achieve those results. Metrics like credit ratings are incredibly useful tools that provide a straightforward way to measure the credit risk of your assets. By digging into these details, you gain a deeper understanding of the drivers behind your portfolio’s performance and can make more informed decisions about future adjustments.
When to Seek Professional Management
Managing a fixed income portfolio can feel straightforward at first, but the market has its own set of complexities. While many investors are comfortable managing their own equities, fixed income requires a different kind of analysis, especially when it comes to managing risk and changing interest rates. Deciding to work with a professional is a personal choice, but it often comes down to your comfort level, the time you can commit, and the scale of your portfolio. A professional can bring a level of expertise, resources, and discipline that can be difficult to replicate on your own.
They go beyond simply picking bonds; they build a cohesive strategy designed to weather market cycles and meet your specific financial objectives. This involves a deep understanding of macroeconomic trends, credit analysis, and sophisticated portfolio construction techniques. If you find yourself spending more time worrying about your bond holdings than benefiting from their stability, or if your portfolio has grown to a size where mistakes become more costly, it might be time to consider professional management. Let’s look at what a professional advisor brings to the table.
What an Investment Advisor Does
An investment advisor’s primary role is to create a strategy that fits your life. They help clients work through the complexities of fixed income investing, providing tailored approaches that align with individual financial goals and risk tolerance. This process starts with a deep understanding of what you want to achieve—whether it’s generating steady income for retirement, preserving capital for a future purchase, or balancing your overall portfolio. They don’t just set it and forget it; a good advisor provides ongoing oversight, making adjustments as your needs or the market changes. This partnership allows you to focus on your life, knowing your portfolio is being managed with your specific objectives in mind.
Using Quantitative Analysis Tools
Professionals have access to powerful tools that go far beyond a standard brokerage account. Utilizing quantitative analysis tools allows investment managers to assess risk and return profiles effectively, enabling them to make decisions based on data-driven insights. Think of these as sophisticated modeling systems that can stress-test a portfolio against potential interest rate hikes or an economic downturn. This data-driven approach helps remove emotion from the decision-making process and can uncover opportunities that aren’t immediately obvious. It’s a key part of the modern infrastructure that supports sound investment management, allowing for a more precise and disciplined strategy.
Accessing Professional Research
Making informed decisions requires quality information, and professional managers have access to a wealth of it. Professional research provides insights into market trends, economic indicators, and sector performance, which are crucial for building a resilient fixed income portfolio. This isn’t the kind of information you’ll find in headline news. It includes in-depth credit analysis on individual bond issuers, macroeconomic forecasts from institutional economists, and detailed sector outlooks. This level of detailed insight allows an advisor to be proactive, positioning your portfolio to adapt to changing economic conditions instead of just reacting to them.
Professional Portfolio Construction
Building a durable fixed income portfolio is about more than just buying a few different bonds. Professional portfolio construction involves a diversified approach that combines various fixed income assets to optimize for risk and return. An advisor will strategically blend securities with different maturities, credit qualities, and issuers—from government to corporate bonds—to create a balanced whole. This method is designed to provide more consistent returns and reduce vulnerability to any single point of failure, like a credit downgrade or a sudden shift in interest rates. The result is a thoughtfully structured portfolio built not just for today, but for your long-term financial future.
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Frequently Asked Questions
What’s the simplest way to start investing in fixed income? For most people, the most straightforward entry point is through a fixed income mutual fund or an ETF. These funds hold a diverse collection of bonds, so you get instant diversification without having to research and purchase individual securities yourself. It’s a great way to get exposure to the market while a professional manager handles the day-to-day decisions.
Can you actually lose money on a bond? Yes, it is possible. While bonds are generally more stable than stocks, their value can decrease. This typically happens for two main reasons. First, if interest rates rise, the market price of your existing, lower-rate bond will fall. Second, there’s a chance the issuer could fail to make its payments, which is known as default risk. Understanding these risks is key to making informed investment choices.
Why is fixed income important if it usually offers lower returns than stocks? Think of fixed income as the defense for your portfolio’s offense. While stocks are focused on growth, fixed income is designed for stability and capital preservation. Its main job is to provide a predictable stream of income and act as a cushion during stock market downturns, helping to smooth out your overall returns and reduce volatility.
What’s the difference between a bond’s coupon and its yield? A bond’s coupon is the fixed interest rate it pays, which is set when the bond is first issued. For example, a $1,000 bond with a 4% coupon will pay you $40 each year. The yield, on the other hand, is your actual rate of return based on the price you paid for the bond. Because a bond’s market price can fluctuate, its yield will also change over time.
How do rising interest rates affect my existing bonds? There is an inverse relationship between interest rates and bond prices. When market interest rates go up, newly issued bonds offer more attractive payments. This makes your older bond with its lower fixed rate less desirable, causing its market price to drop. This is most important to consider if you plan to sell your bond before its maturity date.