Fixed-Income Investments: What They Are and How to Invest

Fixed-income investments like corporate and government bonds have a place in every investor’s portfolio, from first-timers to retirees. Here’s why and how to invest in them.
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Fixed-Income Investments: What They Are and How to Get Started

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Fixed-income investments, such as government and corporate bonds, can provide a steady, predictable source of income, often with lower risk than other investments. Along with stocks and stock mutual funds, fixed-income investments make up the backbone of a well-diversified investment portfolio.

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What is fixed-income investing?

Unlike many investments, fixed-income investments don’t need to be sold to generate a profit. To illustrate how this works, let’s look at bonds, one of the most common types of fixed-income investments.

A bond is really just a loan from you to a corporation or government that pays interest over time plus the principal amount at the end of a predetermined period. For example, if you buy a 10-year bond with a face value of $5,000 that pays 3% interest, you’ll earn $150 annually for 10 years. Interest can be paid at different intervals, such as monthly, quarterly or semi-annually. After 10 years, you’ll have earned $1,500 in interest, and the government or corporation will also pay back the principal amount of $5,000.

The periodic interest payments of fixed-income investments are yours to use however you want. These payments will, however, be taxed as income, though there are many nuances to this, as outlined below.

One important note: Just like stocks, bonds can be bought and sold on the secondary market — which most investors today access through an online brokerage — giving them a value that could be more or less than they initially cost. Selling a fixed-income investment for a profit on the market is an option, though it’s often the regular payments investors are after, not the capital gains.

Fixed-income investments extend beyond bonds, though. Instruments such as preferred stocks or bank certificates of deposits are also included in this category. However, for many investors, bonds will make up most of their fixed-income holdings.

» Ready to get started? See our best brokers for bonds

Benefits of fixed-income investments

Fixed-income investments are a staple in any investment portfolio for several reasons, including that they provide a steady source of income.

Another primary reason is diversification. The goal of diversification is to lower the volatility of your portfolio’s performance by spreading the risk. This can be accomplished through stocks alone—investing in various companies from different sectors is a form of diversification—but fixed-income investments provide even more stability for one main reason: Bond values often behave inversely to stock values.

The value of bonds typically rises and falls opposite to stocks, partly because investors see bonds as a safer place to put funds during volatile periods (more on this below). So, if the stock portion of your portfolio is down 10% but the bond portion is up 4% (and your portfolio is 50% bonds and 50% stocks), your overall losses are only 6%.

Brett Koeppel, a certified financial planner in Buffalo, New York, and founder of Eudaimonia Wealth, says investors can think of fixed-income investments as “shock absorbers” against market downturns.

“During stock market volatility, fixed income typically maintains or even increases in value,” Koeppel says. “By spreading your holdings across different asset classes, you’ll be in a better position for rebalancing opportunities in order to make sure your money is properly aligned to life and what you’re hoping to achieve by investing.”

So, how do you know the right allocation between stocks and bonds? According to Koeppel, there are two main things to consider when assigning your portfolio’s allocation: where the fixed income fits into your overall financial picture and when you expect to use it.

In general, advisors typically recommend allocating toward fixed-income investments as retirement approaches. Doing so will reduce the risk of market-based turmoil taking an oversized bite from your portfolio at a bad time.

» Learn more about the bond market

Risks of fixed-income investments

Bonds are often less risky than stocks, but they have a few risks worth considering.

Default

When buying bonds, consider the issuer's creditworthiness. That is, how likely is it that the government or company will repay its debt to you? If the issuer declares bankruptcy, the interest payments will stop, and you might not get back your entire principal. You can learn about an issuer’s creditworthiness by checking its credit quality ratings through firms like Moody’s Analytics and Standard & Poor’s.

For reference, investment-grade bonds are the least likely to default and have a credit rating of BBB or above (Standard and Poor’s) or Baa and above (Moody’s). Conversely, bonds below this threshold fall into the high-yield bond — otherwise known as junk bond — territory.

While this isn’t much of a risk for U.S. government bonds, the risk of default should definitely be a consideration when buying corporate bonds, says Koeppel.

“With corporate bonds, there is a trade-off between the amount of interest you receive from a bond and the perceived creditworthiness of the issuer, or the likelihood that the company repays your full investment,” Koeppel says. “High-yield bonds pay you more in interest than investment-grade bonds because there is a greater possibility that the issuer could default on its debt obligation. If that happens, you may not receive the full value of what you originally invested.”

Interest rates

Much of a bond’s value comes from its periodic fixed interest payments. If overall interest rates rise, however, newly issued bonds—and their higher interest payments—will become more attractive, lowering the market value of older bonds with lower interest rates.

Conversely, when interest rates fall, newly issued bonds will offer lower interest payments, making the older bonds — whose payments are now higher than the new bonds — more attractive.

» Learn more about how interest rate risk affects bonds.

Low returns

Bonds may be less risky than stocks, but they often don’t offer investors the same level of returns. Typically, investors allocate more of their portfolio toward stocks early on, then gradually shift it to bonds as they near retirement. This strategy maximizes long-term growth while minimizing risk as retirement approaches. Even with diligent saving, an all-bond portfolio may not grow enough for retirement.

» Learn more about what a bond market crash is and how to prepare.

Types of fixed-income investments

There is a wide range of fixed-income investments. See the most common below.

Treasury securities

Treasurys are the federal version of municipal bonds, and since 2012, they have made up the most significant portion of the U.S. fixed-income market.

These investments are issued and backed by the U.S. government and come in three forms: notes, bills and bonds. The biggest difference between these three is how long it takes for each one to reach maturity, as noted below:

The risk of the U.S. government defaulting on its bonds is virtually nonexistent, which secures bonds' status as a safe long-term investment with consistent returns.

Municipal bonds

State and local governments issue municipal bonds, similar to how the federal government sells Treasury bonds. But they often come with an additional benefit: federal tax exemption.

Generally, the interest generated by municipal bonds is free from both federal and state taxes (although this can vary by state). However, they typically provide lower yields than other forms of bonds. These are often recommended for investors already in high tax brackets.

Municipal bonds are generally low risk, as municipalities can introduce new taxes to pay back bondholders. Between 1970 and 2022, the five-year municipal bond default rate was just 0.08%

.

Corporate bonds

Corporate bonds offer more risks and rewards than municipal and treasury bonds. These investments account for about 19% of the U.S. fixed-income market.

Corporate bonds act similarly to Treasury securities, except you’re lending money to a corporation, not the government. The more stable and established the company, the safer your investment will be. This is where the aforementioned credit ratings come into play. Highly rated companies are the least likely to default on their debt, making their bonds strong candidates for reliable fixed-income vehicles.

High-yield bonds

Moving up the risk/return ladder, you'll find high-yield bonds. These “junk” fixed-income securities fall below the investment-grade threshold assigned by credit rating agencies. Still, as their name suggests, they tend to offer higher interest payments in return for taking on more risk.

Bond funds

Mutual funds and ETFs offer all the fixed-income investments discussed above. Bond funds bundle several types of bonds into a single basket, adding even more diversification to your portfolio through a single investment.

Fixed-income taxes

Taxes on fixed-income investments vary, though these differences are relatively straightforward. The table describes a type of security, the state and federal taxes on interest payments and the capital gains taxes you’d incur if you sell the bond before maturity.

Federal income (interest payments)

State income (interest payments)

Capital gains (sell before maturity)

Municipal bonds

Typically no

Varies by state

Yes

Treasury securities

Yes

No

Yes

Corporate bonds

Yes

Yes

Yes

High-yield bonds

Yes

Yes

Yes

How to invest in fixed-income securities

Ready to start generating fixed income? Here’s how.

New-issue Treasury securities. The easiest way to buy newly issued U.S. Treasury securities is through treasurydirect.gov.

Municipal bonds. There are a few ways to buy municipal bonds, but the easiest would be through a brokerage account. Most major online brokerages will have municipal bonds on offer.

Corporate and high-yield bonds. To purchase these, you’ll need a brokerage account. Once you’ve set up your account, you can use the brokerage’s screening tools to find the bonds that best suit your situation and portfolio.

Secondary market. You’ll need a brokerage account to buy or sell all bonds on the secondary market.

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