What is a 'Fixed-Income Security'
A fixed-income security is an investment that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. Unlike a variable-income security, where payments change based on some underlying measure such as short-term interest rates, the payments of a fixed-income security are known in advance.
BREAKING DOWN 'Fixed-Income Security'
A fixed-income security, commonly referred to as a bond or money market security, is a loan made by an investor to a government or corporate borrower. The borrower, or issuer, promises to pay a set amount of interest, called the coupon, on a predetermined basis until a set date. The issuer returns the principal amount, also called the face or par value, to the investor on the maturity date.
Examples of Fixed-Income Securities
Treasury bills are sold by the U.S. government. Corporate bonds are issued by companies. Municipal bonds are issued by states, their agencies and subdivisions. A certificate of deposit (CD) is issued by a bank. Preferred stock pays a dividend in a set dollar amount or percentage of share value on a predetermined schedule. Take for example, a 5% fixed-rate government bond where a $1,000 investment results in an annual $50 payment until maturity when the investor receives the $1,000 back. Generally, these types of assets offer a lower return on investment because they guarantee income.
Benefits of Fixed Income
Fixed-income securities generate regular income, reduce overall risk and protect against volatility of a portfolio. The securities can appreciate in value and offer more stability of principal than other investments. Corporate bonds are more likely than other corporate investments to be repaid if a company declares bankruptcy.
Risks of Fixed-Income Securities
The generally low risk of investing in fixed-income securities results in typically low returns and slow capital appreciation. A principal balance may be tied up for a long time, resulting in lost income by not investing in other securities. Interest rate fluctuations cause bond prices to change, potentially resulting in lost income by having money locked into a lower-interest bond and not being able to invest in a higher-interest bond. Bonds issued by a high-risk company may not be repaid, resulting in loss of principal and interest. Investing in international bonds may result in losses due to exchange rate fluctuations. For example, if a U.S. investor owns bonds denominated in euros, and the euro decreases in value relative to the U.S. dollar, the investor’s returns are lowered.