Fixed-Income Security Definition, Types, and Examples

What Is a Fixed-Income Security?

A fixed-income security is an investment that provides fixed, periodic interest payments and returns the principal amount at maturity. Corporations, municipalities, or the government typically issue fixed-income securities to raise capital for a project or budget item. The main appeal of fixed-income securities is their ability to offer predictable income over time. However, the trade-off is usually lower returns compared to more volatile investments like stocks.

How Fixed Income Security Works

Fixed-income securities work on a simple principle: You lend money by buying a debt instrument from an issuer (corporation, government, municipality) for a set period. In exchange, the issuer agrees to pay periodic interest, usually semiannually, in coupon payments and repays the principal when the security matures. 

Fixed income securities attract conservative investors for their predictability and low volatility. 

Additionally, these investments can play a key role in diversified portfolios, helping offset the volatility of more high-risk assets.

Types of Fixed-Income Securities

While fixed income securities provide predictable income and a return of principal at maturity, they vary significantly based on the issuer, credit rating and risk involved. Here's a breakdown of some common types:

Municipal Bonds

Municipal bonds are a debt obligation issued by a state or local government to fund infrastructure and public projects such as schools, hospitals, bridges, and highways. Municipal bonds, also known as munis, pay interest income exempt from federal taxes and, for some residents, state and local taxes.

Municipal bonds are typically issued in $5,000 increments, making them accessible to many investors. Muni's tax exemption status makes them particularly appealing to investors in high tax brackets. However, many retirees and investors can benefit from diversification and income provided through bond products.

Corporate Bonds 

Corporate bonds are issued by companies to raise funds for business growth, day-to-day operations, or capital expenditures. Bonds bought from companies do not represent ownership in the company, nor do they have voting rights. However, they do offer investors predictable interest payments, usually every six months. 

Based on their credit rating, corporate bonds are either investment-grade or non-investment-grade. Corporate bonds are classified by their maturity period as short-term, medium-term, or long-term.

Treasury Bills

Treasury bills, or T-bills, are short-term debt obligations from the U.S. Government, ranging in maturity from four to 52 weeks. Because short maturities don't allow much time for interest to accrue or for periodic payments, the U.S. Treasury issues T-bills at a discount from par value. Investors then receive the full par value at maturity. T-bills are considered very safe because they are backed by the full faith and credit of the U.S. government.

Treasury Notes

Treasury notes, or T-notes, are issued by the U.S. Treasury Department and backed by the U.S. government. They are intermediate-term and mature in two to ten years. Investors purchase T-notes in increments of $100 and pay semiannual interest payments at fixed interest rates. At maturity, the investor receives their full principal repayment.

Treasury Bonds

Treasury bonds, or T-bonds, are the longest-maturing bonds of the government-backed debt obligations. T-bonds, like T-notes, are sold in $100 increments. However, investors purchase T-bonds through auctions, and maturities are 20 or 30 years. T-bonds appeal to investors looking for long-term diversification, offering steady income and security. T-bonds interest is exempt from state and local taxes, so they're a powerful retirement asset in a diversified portfolio.

Certificates of Deposit

Certificates of Deposit (CDs), issued by banks and credit unions, are another commonly recognized fixed income security. Because CDs require investors to lock up their money until maturity, they usually offer higher interest rates than savings accounts.

CDs are also considered low-risk, as they're typically insured—by the FDIC for banks and the NCUA for credit unions—up to certain limits. Standard CDs start at $500 or $1,000, though some have no minimums. Jumbo and high-yield CDs require larger deposits but offer even better rates.

U.S. Savings Bonds

U.S. savings bonds are another debt obligation issued by the U.S. government. These fixed income securities fund federal spending projects. Like T-bills, bonds are issued at a deep discount, sometimes as much as 50%, and investors receive face value at maturity.

U.S. savings bonds earn interest for up to 30 years. Minimum purchases for savings bonds are $25 and interest is free from state and local taxes.

Preferred Stock

Preferred stock shares certain characteristics with fixed-income securities, such as paying fixed dividends. However, unlike traditional fixed income securities, these dividends are based on a percentage or dollar amount of the stock's par value, assigned at issuance.

Dividends are often higher than those of common stocks but can be suspended if the company faces financial trouble. Preferred stock typically doesn't have a maturity date, which differentiates it from other fixed-income securities.

Fixed Income Credit Ratings

Independent credit agencies such as Moody's Investor Service, Standard & Poor's Global (S&P Global), and Fitch's Ratings evaluate the creditworthiness of issuers of fixed-income securities. These ratings help investors gauge the risk of default. Fixed income securities may score from AAA to D (for default).

• Investment-grade bonds are rated BBB- (S&P/Fitch) or Baa3 (Moody’s) and above. These are considered lower-risk investments.
• Speculative-grade bonds are rated BB+ (S&P/Fitch) or Ba1 (Moody’s) and below, indicating higher risk and higher potential returns.

Government-backed securities like Treasury bills or bonds are typically assumed to have an AAA rating due to the U.S. government's creditworthiness.

Pros and Cons of Fixed Income Security 

The Bottom Line

Fixed income securities offer investors predictable income and portfolio diversification. Some fixed income securities also have significant tax benefits, particularly for investors in high tax brackets.

These investments are generally safe, but investors should consult credit ratings and research before committing- especially because of the illiquidity of fixed income securities. If you're considering adding fixed income securities to your portfolio, consider consulting with a financial advisor to determine which fixed income securities are right for you based on your risk tolerance, timeline, and goals.