Definition of Fixed-Income Security
A fixed-income security is an investment that provides a return in the form of fixed periodic interest 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.
Advantages of Fixed-Income Securities
Fixed-income securities provide steady interest income to investors throughout the life of the bond. Fixed-income securities can also reduce the overall risk in an investment portfolio and protect against volatility or wild fluctuations in the market. Equities are traditionally more volatile than bonds meaning their price movements can lead to bigger capital gains but also larger losses. As a result, many investors allocate a portion of their portfolios to bonds to reduce the risk of volatility that comes from stocks.
It’s important to note that the prices of bonds and fixed income securities can increase and decrease as well. Although the interest payments of fixed-income securities are steady, their prices are not guaranteed to remain stable throughout the life of the bonds. For example, if investors sell their securities prior to maturity, there could be again or loss due to the difference between the purchase price and sale price. Investors receive the face value of the bond if it’s held to maturity, but if it’s sold beforehand, the selling price will likely be different from the face value.
However, fixed income securities typically 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. For example, if a company is facing bankruptcy and must liquidate its assets, bondholders will be repaid before common stockholders.
Corporate bonds are backed by the financial viability of the company. In short, corporate bonds have a higher risk of default than government bonds. Default is the failure of a debt issuer to make good on their interest payments and principal payments to investors or bondholders.
Fixed-income securities are easily traded through a broker and are also available in mutual funds and exchange-traded funds. Mutual funds and ETFs contain a blend of many securities in their funds so that investors can buy into many types of bonds or equities.