What is Fixed Income Investing?
Definition, Investment Types and Strategies for Fixed Income Mutual Funds
What does it mean when you see the term 'fixed income' in the world of investing? Although you've likely heard the term before, you might not know quite what fixed income means or how it can be beneficial for you and your portfolio of mutual funds.
Before you learn how to create a fixed income investment strategy, it's wise to begin your lesson with the fixed income definition and what it means to be a fixed income investor.
Fixed Income Definition for Investing
Fixed income can refer to an investment strategy or style that is intended to provide an investor with relatively fixed or stable income in the form of interest or dividends. Fixed income can also refer to investment types within an investment portfolio, such as bonds and bond mutual funds. From a lifestyle and financial perspective, fixed income can also refer to a person's individual or household income, which is fixed (generally unchanging).
Fixed Income Investment Strategy: Types of Fixed Income Investments
When building a portfolio of mutual funds, the term fixed income generally refers to the portion of the portfolio that consists of funds that are relatively low in market risk and they pay dividends or interest, typically with bonds and bond mutual funds, to the investor for purposes of generating income.
For example, bonds pay a stated interest rate in the form of periodic payments over a fixed term, hence the term fixed income. The overall idea for the fixed income investment strategy is to generate stable and predictable returns. Fixed income investment types can also include money market funds, Certificates of Deposit (CDs) and/or various types of annuities for the fixed income portion of your portfolio.
Fixed Income As a Retirement Lifestyle
The most common purpose for the fixed income investment strategy is for retirement. This is a time in life where achieving stable and predictable returns is most important. A person in retirement may rely on income sources, such as Social Security, pensions, annuities and/or investment accounts, that produce the same amount of income (or an amount increasing at a small, nominal rate) on a year-to-year basis.
In different words, this person's income does not vary materially over time and they may have very little ability to absorb significant increases in periodic expenses. In this regard, the person's income is "fixed." .
Inflation and Rising Interest Rates: The Enemies of Fixed Income Investors
When planning for any kind of long-term investment objective, the investor/saver will need to assume at least an average rate of inflation, which has historically averaged around 3.4%. Investors can find it difficult to get yields that outpace inflation without taking significant risk. They can consider bonds for inflationary environments, such as Treasury Inflation-Protected Securities (TIPS) or they may consider bond funds for rising interest rate environments, although these may provide yields below average rates of inflation.
Bond investors willing to take some risk may also consider high yield (junk) bond funds.
Investors may also consider buying individual bonds, instead of bond mutual funds, when interest rates are expected to rise. They may try a bond ladder approach, where bonds are periodically purchased as yields rise. In summary, bond prices move in opposite direction of interest rates because of the effect the new rates have on the old bonds. When interest rates are rising, new bond yields are higher and more attractive to investors while the old bonds with lower yields are less attractive, thereby forcing prices lower.
Now when you see or hear the term fixed income, you'll know what it means, especially as it is associated with investing and mutual funds.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.