What is Fixed Income in Investing?
Fixed income refers to a type of investment in which real return rates or periodic income is received at regular intervals and at reasonably predictable levels. Fixed income investments are usually in the form of government, municipal, or corporate bonds. The term “fixed” in fixed income refers to both the schedule of obligatory payments and the amount.
Understanding Fixed Income
Investors who purchase fixed income securities are typically looking for a regular, stable income stream. This is achieved by the issuer of the security making regular interest payments to the investor. The interest rate, also known as the coupon rate, is typically fixed for the life of the investment.
Uses of Fixed Income
Fixed income securities are used for a variety of purposes in both personal and institutional investment strategies. Here are some of the main uses:
- Income Generation: Fixed income securities can provide a steady income stream, which can be particularly beneficial for retirees or others who need to fund ongoing expenses.
- Diversification: Including fixed income securities in a portfolio can help diversify investments, potentially reducing risk.
- Preservation of Capital: Because fixed income securities typically have a lower risk of loss than other types of investments, they are often used as a method of preserving capital.
How Fixed Income Works
When an investor purchases a fixed income security, they are essentially lending money to the issuer in exchange for a promise of regular interest payments and the return of the principal at maturity. The interest payments are usually made at a fixed rate and on a fixed schedule, providing a predictable income stream.
Types of Fixed Income Securities
There are several types of fixed income securities, each with its own set of characteristics and risks. Some of the most common include:
- Government Bonds: These are issued by national governments and are generally considered to be low-risk investments.
- Corporate Bonds: These are issued by companies and carry a higher risk than government bonds, but also typically offer higher returns.
- Municipal Bonds: These are issued by states, cities, or other local entities and are often tax-exempt.
Risks Associated with Fixed Income
While fixed income investments are generally considered to be less risky than stocks, they are not without risk. The two main risks associated with fixed income investing are credit risk and interest rate risk.
Credit risk refers to the possibility that the issuer of the bond will not be able to make the required interest payments or return the principal at maturity. This risk is higher with corporate bonds and lower with government bonds.
Interest Rate Risk
Interest rate risk is the risk that the value of a bond will decrease due to a rise in interest rates. When interest rates rise, the fixed interest payments of a bond become less attractive, causing the bond’s price to fall.
In summary, fixed income is a type of investment that provides regular income payments at a fixed rate. While they are generally considered to be less risky than stocks, fixed income investments do carry some risk, particularly credit risk and interest rate risk.