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Fixed-income investments pay interest on a regular and predictable schedule. They also return the principal upon maturity. But fixed-income investing is a much broader topic. While investing in fixed income can be simple, there are also some advanced strategies you can use to help achieve your investment goals.

Read: 3 Things You Must Do When Your Savings Reach $50,000

Here’s an overview of what fixed-income investing is, how it may or may not be appropriate for your portfolio and what risks may be involved.

What Is a Fixed-Income Investment?

Bonds are the most common type of fixed-income investment. When an issuer sells bonds to investors, it raises capital in exchange for the promise of regular interest payments. These payments typically come every six months.

At the defined maturity date, the issuer promises to pay investors the par value of the bond, which is typically $1,000. Since the interest rate that bonds pay is fixed at the time of issuance, it has given rise to the classification of “fixed-income” investments.

Generally speaking, bonds are safer investments than stocks, but they do carry their own risks and some can be quite speculative. Rather than hoping for long-term capital gains out of their bonds, fixed-income investors generally just want the regular interest, along with the return of their capital when the bond reaches maturity.

What Are Examples of Fixed-Income Investments?

While bonds are the most commonly cited example of fixed-income investments there are a host of other options as well. Here is a look at eight common fixed-income investments:

  1. Bond mutual funds
  2. Preferred stocks
  3. Fixed annuities
  4. Corporate bonds
  5. Treasury bonds
  6. Municipal bonds
  7. Certificates of deposit
  8. Money market funds

Note that not all securities that are lumped into the “fixed income” category actually have a “fixed” interest rate. For example, bond mutual funds and money market funds, among others, often change their interest rate on a regular basis. But they are still categorized as “fixed-income” investments because they pay investors a regular income stream. 

Although all fixed-income investments pay some type of income, they can accomplish this goal in many different ways.

Bond mutual funds, for example, usually pay investors monthly, but they make no promise of the return of principal. Rather, as bonds come due, managers reinvest those proceeds into new bonds, keeping the income stream continuous.

This can make bond funds riskier in the eyes of some investors. But it can come with a tradeoff of higher income compared to owning an individual bond outright. 

Good To Know

Certain categories of bonds can be riskier to own than others. Corporate bonds, for example, promise principal repayment at maturity, but that “promise” is only as good as the financials of the underlying company. If the business falters, it may suspend payments or even default on its bonds.

Treasury securities, on the other hand, are backed by the “full faith and credit” of the U.S. government, making them among the safest investments in the world. This is why many corporate bonds carry ratings from outside agencies. These ratings help differentiate their risk level vis-a-vis Treasury securities and other corporate bonds.

What Is the Best Fixed-Income Investment?

As each investor has their own personal financial objectives and risk tolerance, the best choice for one might not be the same for another. But good fixed-income investments do have two main factors in common:

  • A safe issuer
  • A high interest rate

The whole point of buying a fixed-income investment is to earn interest, so the best fixed-income investments pay well. But a high income isn’t worth anything if the issuer defaults and you end up losing your principal. So picking the right investment is a balancing act between risk and reward.

More aggressive investors might take a chance on a lower-rated issuer in exchange for a high income. While those simply looking to preserve their principal will stick to the safest investments available, such as Treasury bills or short-term CDs.

Can Fixed-Income Funds Lose Money?

An important thing for investors to know is that yes, fixed-income mutual funds can lose money.

Unlike individual bonds, which have a stated date at which issuers will return the principal to investors, mutual funds have no such promise. In other words, an investor could hold a bond mutual fund forever and never receive the principal back — at least, not until the fund is sold. This gives bond mutual funds a longer duration, which makes them more vulnerable to movements in interest rates.

This interest-rate risk is important to factor into a bond mutual fund purchase. When interest rates rise, bond prices fall. If you own an individual bond and wait until maturity, you can avoid interest-rate risk. Even if interest rates go sky high, the issuer is obligated to pay you back the par value of the bond.

But with bond mutual funds, this safeguard doesn’t exist. If interest rates go high, the net asset value of a bond fund will fall, and it may never recover. You’ll still continue receiving your interest payments — and if rates are higher, the interest your fund pays will increase over time as well — but you may never get back the price you paid for the fund.

Fixed-income funds carry other risks as well. Some of which are the risk of default within the portfolio and the risk that inflation will eat away the purchasing power of investor dollars. But the interest-rate risk is likely the most tangible one for investors, as it affects the day-to-day price of the bond fund.

The Bottom Line

Fixed-income investments are generally a conservative way to earn regular interest payments and protect the value of your principal. However, this only applies if you hold individual bonds or CDs to their maturity date. Selling prematurely can subject you to interest-rate risk, the same that always affects bond funds.

To determine which fixed-income investment will offer you the right balance of risk and reward, be sure to speak with a financial advisor about your objectives and your risk tolerance.

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