Definition
Fixed income refers to a type of investment in which real return rates or periodic income is received at regular intervals and at relatively predictable levels. Most commonly, these investments include government, municipal, and corporate bonds, certificates of deposit, and preferred stock. Investors typically prefer fixed income securities to reduce overall portfolio risk, derive regular income, or for diversification purposes.
Key Takeaways
- Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. This typically includes government, corporate and municipal bonds, preferred stock, money market instruments, and mortgage-backed securities.
- The biggest advantage of fixed income investments is the reduction of risk. Investors receive their interest income at regular intervals, providing a steady source of income. This makes it a suitable investment choice especially for risk-averse investors, retirees, or those looking for a steady cash flow.
- However, fixed income securities tend to offer lower returns on investment than equity securities because of the lower risk involved. Additionally, they are susceptible to inflation risk. If inflation exceeds the rate of return on the bonds, it could erode the profitability of your investment.
Importance
Fixed income is a crucial term in finance as it refers to a type of investment security that pays investors fixed interest payments until its maturity date. Upon maturity, the principal amount that was initially invested is returned.
These investments are vital to investors – particularly retirees – who prefer low-risk investments and require steady income flows. They largely consist of government, municipal, and corporate bonds, certificates of deposit, and preferred stock.
In the context of personal finance, fixed income could also pertain to a type of earning wherein individuals receive a regular, predictable income like pensions or social security benefits. Understanding fixed income is paramount, as it helps an investor measure, analyze, and manage the risk and return associated with their investment portfolio.
Explanation
Fixed income is primarily used for diminishing financial uncertainty, and it plays a pivotal role in helping entities to manage monetary risks. This could include individuals seeking a predictable income stream after retirement, or large corporations looking to hedge interest rate fluctuations.
The key purpose of fixed income is to provide predictability in cash flows, which helps in forecasting future budgets with a higher accuracy and reducing exposure to financial volatility, enabling better economic planning for the individual or organization involved. Moreover, fixed income operates as an essential device for raising capital in the financial markets, allowing governments, municipalities, and companies to fund their operations and implement growth plans.
Investors purchase these securities in return for regular interest payments, serving the purpose of preserving capital while earning a steady income. Hence, it’s also seen as a safer investment category, making them popular among conservative investors with a low risk tolerance, such as pension funds or retirees.
Examples of Fixed Income
Bonds: This is one of the most common examples of fixed income. These are essentially loans that an investor makes to a borrower, typically a corporate entity or a governmental body. In exchange for the investor’s money, the borrower promises to pay a predetermined rate of interest (called a coupon) for a specific period of time. The borrower also assures to return the principal amount at the end of this period (called the maturity date).
Certificates of Deposit (CDs): A CD is another prominent example of a fixed income instrument. It is a time deposit offered by banks with a fixed term, typically monthly, three months, six months, or one to five years. With a CD, the bank promises to pay a fixed rate of interest throughout the term and return the initial deposit at the end.
Pension Annuity: In this fixed income scheme, an individual pays into a fund over an extended period. After retirement, he/she receives a steady income from the annuity, usually until death. The income is fixed based on the total contribution made, the time of the contribution, and the individual’s life expectancy at the time of retirement.
FAQ Section: Fixed Income
What is Fixed Income?
Fixed income refers to any type of investment under which the borrower or issuer is obliged to make payments of a fixed amount on a fixed schedule. This often includes investments like bonds and dividend-yielding stocks.
What are some examples of Fixed Income assets?
Fixed Income assets include bonds, treasury bills, corporate bonds, municipal bonds, and other types of loan-oriented investments. These assets typically pay a return on a fixed schedule, hence the name “fixed income.”
What are the risks associated with Fixed Income investment?
The primary risk associated with fixed income investment is credit risk. This is the risk that the issuer of the bond or other fixed income security will default and fail to pay the interest and/or principal. Other key risks include interest rate risk and inflation risk.
Who should consider Fixed Income investing?
Investors seeking a stable source of income and a lower risk profile might consider fixed income investing. It is particularly popular among retirees or those nearing retirement, who require predictable income streams.
How are Fixed Income investments taxed?
Tax on fixed income investments often vary and depend on the type of investment, the holding period of the investment and the personal income bracket of the investor. It also varies by country and its specific taxation rules. It is recommended to consult a tax advisor for specifics.
Related Entrepreneurship Terms
- Bonds
- Coupon Rate
- Maturity Date
- Yield to Maturity (YTM)
- Face Value
Sources for More Information
- Investopedia: This is a premier resource for investment and financial education. It offers extensively detailed information about Fixed Income.
- Morningstar: It is a respected source of independent investment analysis, data, news, and research. Their in-depth reports and ratings can provide valuable insights into fixed income.
- U.S. Securities and Exchange Commission (SEC): The SEC offers comprehensive information on various topics in finance including Fixed Income. Truly reputable and reliable.
- Bloomberg: Known for its coverage of financial news and market insights, Bloomberg provides up-to-date information and analysis on Fixed Income.
