What Is a Fixed-Income Security?

What Is a Fixed-Income Security?

Let me explain what a fixed-income security is: it's an investment that gives you fixed, periodic interest payments and returns your principal at maturity. Issuers like corporations, municipalities, or governments use these to raise money for projects or budgets. You get predictable income from them, but remember, that often means lower returns than riskier options like stocks.

How Fixed-Income Securities Work

These securities operate on a basic idea: you lend money by purchasing a debt instrument from an issuer, such as a corporation, government, or municipality, for a specific period. In return, the issuer pays you interest periodically, often semiannually through coupon payments, and repays the principal at maturity. They're ideal for conservative investors like you who value predictability and low volatility. Plus, they can balance out the ups and downs of riskier assets in your portfolio.

Types of Fixed-Income Securities

Fixed-income securities differ based on the issuer, credit rating, and risk level, but they all promise predictable income and principal return. Take municipal bonds, for instance: these are issued by state or local governments to fund projects like schools, hospitals, bridges, and highways. Known as munis, they offer interest exempt from federal taxes, and sometimes state and local taxes too, especially if you're in a high tax bracket. They're issued in $5,000 increments, making them accessible, and they provide diversification and income for retirees and others.

Corporate bonds come from companies raising funds for growth or operations. Buying them doesn't give you ownership or voting rights, but you do get predictable semiannual interest. They're rated as investment-grade or non-investment-grade based on credit, and classified by maturity: short-term, medium-term, or long-term.

Treasury bills, or T-bills, are short-term U.S. government debts maturing in four to 52 weeks. Sold at a discount, you get the full par value at maturity—no periodic interest, but very safe due to government backing.

Treasury notes, or T-notes, are intermediate-term, maturing in two to ten years, bought in $100 increments with semiannual fixed interest and principal repayment at maturity, also government-backed.

Treasury bonds, or T-bonds, are long-term, maturing in 20 or 30 years, sold via auctions in $100 increments. They provide steady income, long-term diversification, and interest exempt from state and local taxes, making them strong for retirement portfolios.

Certificates of deposit, or CDs, from banks or credit unions, lock up your money for higher interest than savings accounts. They're low-risk, insured by FDIC or NCUA up to limits, starting at $500 or $1,000, with jumbo versions offering better rates for larger deposits.

U.S. savings bonds fund federal projects, issued at a discount with face value at maturity, earning interest up to 30 years. Minimum $25 purchase, and interest is free from state and local taxes.

Preferred stock acts like fixed-income with fixed dividends based on par value, often higher than common stock dividends, but they can be suspended in tough times and lack a maturity date.

Fixed-Income Credit Ratings

Agencies like Moody's, S&P Global, and Fitch rate issuers' creditworthiness to help you assess default risk, from AAA to D. Investment-grade bonds are BBB- or Baa3 and above, meaning lower risk. Speculative-grade are BB+ or Ba1 and below, with higher risk but potential for better returns. Government securities like treasuries are essentially AAA due to U.S. backing.

Pros and Cons of Fixed-Income Securities

On the plus side, you get predictable scheduled income, lower volatility, principal back at maturity, diversification, and sometimes tax advantages. Drawbacks include lower returns than other investments, interest rate risk where rising rates drop prices, inflation eroding future value, and higher returns often tying to higher default risk.

Are Fixed-Income Securities Safe?

Generally, they're safer than stocks, but not without risks—the safety hinges on the issuer and rating. Government-backed ones like T-bills or munis are safest, though with lower rates.

Should You Include Fixed-Income in Your Portfolio?

Yes, they're great for diversification, stability, and income, depending on your risk tolerance, goals, and timeline.

How to Decide Between Bond Funds and Individual Bonds

Both target diversification and income. Individual bonds give fixed income without management fees but need more capital for variety and are less liquid. Bond funds offer quick diversification and liquidity but have fees and fluctuating returns.

Do All Fixed-Income Securities Have Tax Benefits?

Not all, but some like municipal bonds are federal tax-exempt, and possibly state/local for qualified investors.

The Bottom Line

Fixed-income securities deliver predictable income and diversification, with tax perks for some, especially high-bracket investors. They're mostly safe, but check ratings and research due to illiquidity. If you're adding them, talk to a financial advisor to match your risk, timeline, and goals.