What fixed income investments are

A fixed income investment is a loan you make to a government or company in exchange for regular payments. You lend money upfront — called the principal — and receive a set amount of interest at regular intervals, usually every six months or annually. When the loan term ends, you get your principal back. The "fixed" part means the payment amount does not change, which makes your income predictable.

The most common fixed income investments are bonds. When you buy a bond, you are essentially buying a debt instrument. A government bond means you lent money to a government. A corporate bond means you lent money to a company. Other fixed income investments include certificates of deposit (CDs) from banks and Treasury securities from the U.S. government.

Fixed income investments differ from stocks because you are not buying ownership in a company. You are a creditor, not an owner. That means you get paid before stockholders do if the company runs into trouble, but you do not benefit if the company becomes wildly profitable.

Key Takeaways

  • Fixed income investments pay you a set amount of interest at regular intervals, making your income predictable and separate from how well the company or government performs.
  • Bonds are the most common type, and they come from governments, corporations, and municipalities — each with different risk levels and tax treatment.
  • The interest rate you receive depends on how risky the borrower is seen to be, how long you lend the money, and what interest rates are in the broader economy.
  • Your principal can lose value if interest rates rise after you buy the bond, because new bonds will pay more and yours becomes less attractive to sell.
  • Fixed income investments are generally less volatile than stocks but also produce lower returns over long periods.

How interest rates and bond prices work together

When you hold a bond, its value in the market moves in the opposite direction from interest rates. If you buy a bond paying 3 percent and interest rates rise to 5 percent, new bonds will pay 5 percent. Your 3 percent bond becomes less attractive, so if you try to sell it before maturity, you will have to accept a lower price to compensate the buyer for the lower payment.

This matters most if you need to sell before the bond matures. If you hold the bond until the end of its term, you get your full principal back regardless of what happened to interest rates in between. But if you need cash early, rising rates mean you take a loss.

The opposite is also true: if interest rates fall after you buy a bond, your bond becomes more valuable because it pays more than new bonds do. You could sell it for more than you paid. This is why bond prices and interest rates move in opposite directions.

Different types of fixed income investments and their risks

U.S. Treasury bonds, notes, and bills are backed by the federal government and carry the lowest default risk — the risk that the borrower will not pay you back. Because they are safest, they pay the lowest interest rates. You can buy them directly from TreasuryDirect.gov or through a broker.

Municipal bonds are issued by states, cities, and local governments to fund infrastructure projects. They often offer tax advantages: the interest you receive may not be taxed by the federal government, and sometimes not by your state either. This makes them attractive to people in high tax brackets, even though the interest rate is lower than corporate bonds.

Corporate bonds are issued by companies and pay higher interest rates than government bonds because companies are riskier borrowers. A company can go bankrupt; a government can print money. Within corporate bonds, investment-grade bonds (rated BBB or higher) are considered safer, while high-yield bonds (rated below BBB) pay much more interest but carry real default risk.

Certificates of deposit (CDs) are issued by banks and are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per account. They pay a fixed rate for a set term — typically three months to five years. If you withdraw early, you usually pay a penalty.

How to understand bond ratings and what they mean

Bond ratings tell you how likely a borrower is to pay you back. The three major rating agencies — Standard & Poor's, Moody's, and Fitch — assign letter grades. AAA or Aaa is the safest; D means the bond is in default or near it.

Investment-grade bonds are rated BBB/Baa or higher. These are considered safe enough for conservative investors. Anything below that is called high-yield or junk-grade, and these bonds pay much more interest because the risk of default is real. A company rated BB might have weak finances or operate in a risky industry.

Ratings can change. If a company's finances improve, its bonds might be upgraded, which usually raises the bond's market price. If finances deteriorate, a downgrade can cause the price to fall. You can find bond ratings on financial websites like Morningstar, Bloomberg, or your broker's platform.

What affects the interest rate you receive

Three main factors determine the interest rate on a fixed income investment: the creditworthiness of the borrower, the length of the loan, and the broader interest rate environment.

A borrower with a strong credit rating pays less interest because lenders see them as safer. The U.S. government pays very little; a startup company pays much more. The longer you lend your money, the more interest you usually receive, because you are taking on more risk that something could go wrong over time. A 30-year bond pays more than a 2-year bond from the same borrower.

The broader economy also matters. When the Federal Reserve raises its benchmark interest rate, new bonds across the market pay more. When the Fed cuts rates, new bonds pay less. This is why older bonds become more or less valuable — they are paying a fixed amount in a changing interest rate environment.

Fixed income versus stocks: what the differences mean for your money

Fixed income investments are generally less volatile than stocks. Your payment amount does not change based on company performance or market mood. This makes them useful for people who need predictable income or want to reduce the ups and downs in their portfolio.

Over very long periods — 20 years or more — stocks have historically returned more than bonds. But stocks also have years where they lose significant value. Bonds are more stable but grow your money more slowly. Many investors hold both: bonds for stability and income, stocks for growth.

Fixed income investments also behave differently during economic downturns. When the economy weakens, people often move money into bonds because they are safer. This can cause bond prices to rise even as stock prices fall. This opposite movement is one reason investors combine them.

How to buy fixed income investments

You can buy bonds and other fixed income investments through several routes. Treasury securities can be purchased directly from TreasuryDirect.gov with no fees. You can also buy them through a broker like Fidelity, Charles Schwab, or Vanguard.

Corporate and municipal bonds are usually bought through a broker. Some brokers charge a commission per bond; others charge a markup built into the price. Ask what you will pay before you buy. Bond mutual funds and exchange-traded funds (ETFs) let you own many bonds at once with a single purchase, which spreads your risk across many borrowers.

CDs are sold by banks and credit unions. You can shop rates on websites like Bankrate or DepositAccounts.com. The FDIC insurance limit is $250,000 per depositor per bank, so if you have more than that, spread it across multiple banks.

Frequently Asked Questions

Can I lose money on a bond if I hold it until maturity?

If you hold a bond until maturity, you will receive your full principal back, assuming the borrower does not default. However, you can lose money if the borrower goes bankrupt or stops paying. This is why bond ratings matter — they reflect the risk that the borrower will not pay you back.

What is the difference between a bond and a bond fund?

A bond is a single loan to one borrower. A bond fund pools money from many investors to buy hundreds or thousands of bonds. Bond funds offer instant diversification but charge annual fees, and their value fluctuates daily. Individual bonds offer predictability if you hold to maturity but require more money upfront and more research.

Why would I buy a bond that pays less than inflation?

Some bonds pay less than the inflation rate, meaning your money loses purchasing power over time. Investors buy them anyway for safety and stability, especially near retirement when protecting what you have matters more than growing it. They also serve as a portfolio anchor during stock market downturns.

How do I know if a bond is a good deal?

Compare the interest rate to what similar bonds are paying. A bond paying 4 percent from a company rated BBB should pay roughly the same as other BBB-rated corporate bonds of the same length. If it pays significantly less, it may be overpriced. Your broker or a financial website can show you comparable bonds.

What happens to my bond if the company gets bought?

Usually your bond continues unchanged — you still receive the same payments. However, the new owner might refinance the debt, which could change the terms. In rare cases, a buyout might trigger a "change of control" clause that lets you sell the bond back at par value. Check the bond's terms before you buy.