What is ‘Fixed Income’
Fixed income is a type of investing or budgeting style for which real return rates or periodic income is received at regular intervals and reasonably predictable levels. Fixed-income investors are typically retired individuals who rely on their investments to provide a regular, stable income stream. This demographic tends to invest heavily in fixed-income investments because of the reliable returns they offer.
Breaking Down ‘Fixed Income’
Fixed-income investors who live on set amounts of periodically paid income face the risk of inflation eroding their spending power. The most common type of fixed-income security is a bond. Bonds are issued by federal governments, local municipalities and major corporations. Fixed-income securities are recommended for investors seeking a diverse portfolio; however, the percentage of the portfolio dedicated to fixed income depends on your personal investment style. There is also an opportunity to diversify the fixed-income component of a portfolio. For instance, you might have a portfolio with 50% in investment-grade bonds, 20% in Treasury’s, 10% in international bonds and the remaining 20% in high-yield bonds. Riskier fixed-income products, such as junk bonds and longer-dated products, should comprise a lower percentage of your overall portfolio.
Fixed Income vs. Stocks
There are two main types of investments in the capital markets: debt and equity. Equity, or company shares, is considered ownership in the company, and investors receive a return based on share price appreciation and/or dividends. Fixed-income investors do not have an ownership stake in the company but act as lenders of capital. In exchange for interest, fixed-income investors lend their money to firms. As a result, they are considered creditors and often have a claim in case of bankruptcy or default, though small, making the investment less risky than equity. In case of default, shareholders lose all cash invested.
The interest payment on fixed-income securities is considered regular income and is determined based on the creditworthiness of the borrower and current market rates. In general, bonds and fixed-income securities with longer-dated maturities pay a higher rate, also referred to as the coupon rate, because they are considered riskier. The longer the security is on the market, the more time it has to lose its value and/or default. At the end of the bond term or bond maturity, the borrower returns the amount borrowed, also referred to as the principal or par value.
Examples and Risks
Some examples of fixed-income investments include Treasury’s, money market instruments, corporate bonds, asset-backed securities, municipal bonds and international bonds. The primary risk associated with fixed-income investments is the borrower defaulting on his payment. Other considerations include exchange rate risk for international bonds and interest rate risk for longer-dated securities.