What is a Fixed-Income Investment?
Fixed-income assets are a class of investments that provide a fixed schedule of income based on the coupon rate – or interest rate – which in part determines the yield of the asset. The yield of a fixed-income asset is based on the interest rate and is divided and distributed in equal parts on a fixed schedule. For example, if the interest rate on a $10 asset is 2 percent, and the schedule for distributing the yield on the investment is semi-annual until the asset matures after one year, the total return of 20 cents would be distributed in one payment of 10 cents after six months and another at 12 months.
Examples of Fixed-Income Investments
While bonds are the most common and well-known example, Certificates of Deposit (CDs), fixed annuities, money market funds, and asset-back securities are also fixed-income assets. In addition, one can invest in fixed-income assets through bond exchange traded funds (ETFs) and bond funds.
- Bonds – Bonds are are fixed-income investments in which the purchaser or investor lends money to an entity such as a government, municipality, or corporation. The issuer of the bond is essentially borrowing an amount from the purchaser equal to the price of the bond, hence why bonds are considered to be a form of debt. In return, the issue pays an interest rate on the bond, which determines the yield that is paid in installments to the investor on a fixed schedule, most often semi-annually. Bondholders will have received both the full return on the bond as well as the amount of the original purchase price of the bond once the bond reaches its maturity date.
- CDs – CDs are certificates issued by banks for an investment of a fixed amount of time known until the maturity date. Banks issue CDs as a means of attracting additional capital, and pay the fixed interest rate in addition to returning the principal value of the CD to investors after the maturity date of the CD. CDs normally have a higher interest rate than most checking and savings accounts, and are therefore may be an attractive option for investors with low-risk, short-term savings or investment goals. CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000. The potential downside and risk to owning CDs is that the money is not as accessible as cash in a money market, checking, or savings accounts, as the investor must wait until the maturity date to receive the full principal of the CD and the interest. Cashing in CDs before the maturity date comes with a penalty that can eat away not only at the interest payment you would have received, but also the principal purchase price of the CD.
- Money Market Accounts – Money market accounts are interest bearing accounts that normally have higher interest rates than checking and savings accounts, and are often considered another attractive option for short-term savings and emergency funds. Investments in money market accounts are more accessible and liquid than CDs, as they often allow investors to write checks from the money in the accounts, albeit sometimes on a more limited basis. Money market deposit accounts are also insured by the FDIC up to $250,000, which provides protection for your principal investments.
- Fixed Annuities – Fixed-income annuities convert a person’s savings into regular income payments over a certain period of time (normally one to ten years). The investor enters in an annuity contract in which they contribute either a lump sum of money or series of contribution and the institution agrees to make regular payments to the investor that incorporates the yield on the investment determined by the interest rate. Fixed annuity contributions are normally tax-deferred, meaning you’ll receive your principal back tax-free, but income and growth on the annuity may be taxable. (You should consult a tax professional before making investment decisions based on expectations of tax deferrals or tax-free growth.)
- Asset-Backed Securities – Asset-backed securities are fixed-income investments that are backed by a pools of assets by a lending institution. The institution offers these securities as a means of raising additional capital. The assets used to back the development and offering of the securities are normally a pool of loans with similar interest rate, structures, and maturity dates. Mortgage-backed securities (MBS) – which are backed by a mortgage or collection of mortgages – are a well-known example of asset-backed securities.