A:

Fixed-income securities attract investors because they provide guaranteed returns in the form of fixed, regular cash payments. However, investing in fixed-income securities also carries some disadvantages. Their generally low risk compared to investments that don't come with guarantees often translates to lower returns. Additionally, many fixed-income securities, such as Treasury bonds (T-bonds), impose penalties on investors who withdraw their premiums before a set period of time has passed.

A fixed-income security is an investment that provides fixed payments at regular intervals for the duration that the investor holds the security. Common forms of fixed-income securities include T-bonds and corporate bonds. Consider an investor who purchases a 20-year T-bond at a par value of $1,000 and an annual yield of 5%. This bond pays the investor $50 per year until the 20 years are over, when his premium of $1,000 is returned.

Preferred stock also falls under the category of fixed-income security. It pays investors a dividend on a fixed schedule. The amount of a dividend is either a fixed dollar amount or a fixed percentage of share value. The dividend payments that a preferred stockholder receives are analogous to the annual payments received by a bondholder. When the investor sells his preferred stock, his premium is returned, plus or minus any gains or losses accrued over time.

Regardless of what the economy or the markets are doing, fixed-income securities pay a return. The bond investor described above receives his $50 per year even during a sharp recession or a depression. The guaranteed dividends received by a preferred stock holder enhance gains and mitigate losses. For example, if the stock falls by 5% but pays a 3% dividend, the investor's loss, effectively, is only 2%.

These built-in advantages come with corresponding disadvantages. In nearly all matters of finance, risk and reward correlate positively. For this reason, high-risk sectors such as tech startups offer investors the potential for the biggest gains. Government securities, while safe, rarely make investors rich in short order. The guaranteed cash payments that fixed-income securities provide lower their risk. With lower risk comes lower rewards. Fixed-income securities typically do not gain as aggressively as securities that do not provide guaranteed fixed payments.

Furthermore, many fixed-income securities tie up an investor's principal balance for a long period of time. If he wants to retrieve it, he's assessed a penalty that often wipes out any money he has made in the interim. For example, T-bonds have maturities of 10 years or greater. An investor isn't returned his premium for a decade or longer. In contrast, traditional stock investing, when done shrewdly, can produce big gains in far less than a decade, and the investor can actually access his money.

RELATED FAQS
  1. What are the main advantages of fixed income securities?

    Learn why the addition of fixed income securities are common among investors who are attempting to limit their exposure to ... Read Answer >>
  2. What are the risks associated with investing in a treasury bond?

    Read about the risks of investing in risk-free U.S. Treasury bonds, including interest rate risk, inflation risk and opportunity ... Read Answer >>
  3. Is a treasury bond a good investment for retirement?

    Understand why Treasury bonds (T-bonds) are a popular choice for investors near retirement and why they are not always suitable ... Read Answer >>
  4. Is preferred stock an equity or a fixed-income security?

    Preferred stock is equity. Preferred stock also (usually) has a fixed dividend payout. This is why some investors have referred ... Read Answer >>
  5. How is the interest rate on a treasury bond determined?

    Explore the difference between interest rates and bond coupons, what determines current yield on debt instruments, and why ... Read Answer >>
Related Articles
  1. Investing

    Future CEO? Get Your Start In Fixed Income

    Discover why working in fixed income can be your ticket to the highest professional goals you've set for yourself.
  2. Investing

    Advanced Bond Concepts

    Learn the complex concepts and calculations for trading bonds including bond pricing, yield, term structure of interest rates and duration.
  3. Investing

    How To Create A Modern Fixed-Income Portfolio

    Exposure to different asset classes is required to generate income, reduce risk and beat inflation. Find out how bonds can help.
  4. Investing

    Corporate Bonds: Advantages and Disadvantages

    Corporate bonds can provide compelling returns, even in low-yield environments. But they are not without risk.
  5. Managing Wealth

    The Different Between Preferred and Common Stock

    Preferred and common stocks are different in two key ways.
RELATED TERMS
  1. Fixed Income

    A type of investing or budgeting style for which real return ...
  2. Interest Rate Risk

    The risk that an investment's value will change due to a change ...
  3. Structured Funds

    A fund that combines both equity and fixed-income products to ...
  4. Interest Rate Sensitivity

    A measure of how much the price of a fixed-income asset will ...
  5. Inflation-Protected Security - IPS

    A type of fixed-income investment that guarantees a real rate ...
  6. Call Premium

    1. The dollar amount over the par value of a callable fixed-income ...
Hot Definitions
  1. Stop-Loss Order

    An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit ...
  2. Acid-Test Ratio

    A stringent indicator that indicates whether a firm has sufficient short-term assets to cover its immediate liabilities. ...
  3. Floating Exchange Rate

    A country's exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that ...
  4. Taxes

    An involuntary fee levied on corporations or individuals that is enforced by a level of government in order to finance government ...
  5. Impaired Asset

    A company's asset that is worth less on the market than the value listed on the company's balance sheet. This will result ...
  6. Solvency Ratio

    One of many ratios used to measure a company's ability to meet long-term obligations. The solvency ratio measures the size ...
Trading Center