Fixed income is an investment that pays a fixed amount on a set schedule until maturity. Fixed-income investments tend to be lower risk than equity investments. The returns are also often lower and usually only consist of fixed-income payments.
Here's a closer look at fixed-income investments and why investors might want to hold them in their portfolios.
What is fixed income?
Fixed income is an asset class. Other common asset classes include equities (e.g., stocks), cash and equivalents, real estate, commodities, and currencies.
Fixed-income investments are debt investments that pay a fixed interest rate on a set schedule. They enable investors to earn stable income until the investment matures. The income is the base return an investor makes from the investment. Upon maturity, an investor will receive their principal back.
An example of fixed-income investment is investing $10,000 into a 10-year bond with a 3.5% interest rate paid every six months until maturity. The investor would receive a fixed income payment of $175 every six months ($350 annually) for the 10-year term. Upon maturity, the investor would get their entire $10,000 principal paid back.
What are the different types of fixed income?
There are many fixed-income investments, which range in return and risk profile. They include:
- U.S. government debt (Treasuries): The U.S. government issues several fixed-income debt securities to help fund its operations. These include Treasury bills (T-bills), Treasury notes (T-notes), Treasury bonds (T-bonds), Treasury inflation-protected securities (TIPS), Series I savings bonds (I bonds), and other savings bonds. They range in duration from four weeks to 30 years. Many investors consider U.S. government debt a risk-free investment, given the extreme unlikelihood of a default.
- Municipal bonds (Muni bonds): State and local governments also issue fixed-income debt securities to help finance local expenditures. Muni bonds also have a very low risk of defaulting.
- Corporate bonds: Companies will also issue debt to finance their operations and expansion. Corporate bonds are riskier than those issued by governments. However, the default risk ranges from low for an investment-grade rated corporate issuer to high for a company issuing junk bonds.
- Bank certificate of deposits (CDs): Many financial institutions offer CDs that pay a fixed interest rate until maturity.
- Mortgages, loans, and related securities: Individuals and institutions can also invest in loans or a package of loans made directly to consumers and businesses.
Related Investment Topics
Allocation | Average Annual Return | Best Year | Worst Year | Years with a loss |
|---|---|---|---|---|
100% stocks | 12.3% | 54.2% | -43.1% | 25 of 96 |
80% stocks/20% fixed income | 11.1% | 45.4% | -34.4% | 24 of 96 |
60% stocks/40% fixed income | 9.9% | 36.7% | -26.6% | 22 of 96 |
50% stocks/50% fixed income | 9.3% | 33.5% | -22.5% | 20 of 96 |
40% stocks/60% fixed income | 8.7% | 35.9% | -18.4% | 19 of 96 |
20% stocks/80% fixed Income | 7.5% | 40.7% | -10.1% | 16 of 96 |
100% fixed income | 6.3% | 45.5% | -8.1% | 20 of 96 |
As the table shows, adding fixed income to a portfolio can reduce downside volatility and years with a loss in exchange for a lower average annual return.
Because of their stability, many financial advisors recommend that an investor have some fixed income in their portfolio. They have traditionally recommended a 60/40 portfolio (60% stocks and 40% fixed income) because that offers an attractive return profile with lower downside risk compared to portfolios with higher stock allocation. Meanwhile, they often advise investors to increase their exposure to fixed income as they approach retirement.
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