Fixed Income

Fixed income is a category label for investments in which the holder is a lender rather than an owner, and is entitled to payments on a schedule. It is the word that appears on a brokerage statement's allocation pie, in the name of a workplace plan's investment option, and in the second half of the phrase "stocks and fixed income."

It is worth being explicit that this is a market convention rather than a defined term. The SEC's investor.gov glossary, which runs to several hundred entries and carries entries for "bonds" and "current yield," has no entry for "fixed income" at all, while the same site groups its investor education pages under the heading "Bonds or Fixed Income Products." So the label is in official use as an organizing category without carrying an official definition, and its edges are set by convention. That is why one firm's fixed income sleeve includes cash-like holdings and another's does not.

What is inside the sleeve is broader than bonds, and that is the practical reason to know the label. Individual bonds are the core: Treasury, municipal and corporate. Bond funds and bond ETFs hold those instruments in pooled form and are what most people actually own. Beyond them sit certificates of deposit, Treasury bills, money market funds, and, in workplace retirement plans, stable value options. Treasury Inflation-Protected Securities are usually counted here too. Someone reading a plan menu that offers a single "fixed income" choice is being offered one of these, and which one it is changes the answer to almost every question worth asking about it.

The name is a promise about the payments, not about the value. Fixed income says the payment schedule is set by contract. It says nothing about what the holding will be worth on any given day, and the value of most things in the sleeve moves. Why it moves belongs to the bond, which sets out the relationship between prices and interest rates for everything built on that pattern. The point for this page is narrower and is the one the label itself obscures: a portfolio can be entirely fixed income and still be worth less at the end of a year than at the start.

Several members of the category do not have fixed income either, which is the part of the name that ages worst. A money market fund's yield changes as short-term rates change. A bond fund's distribution rises and falls as the bonds inside it are replaced. Floating-rate instruments are built to reset. Treasury Inflation-Protected Securities carry a fixed interest rate that is applied to a principal amount which moves with the Consumer Price Index, so the dollar payments vary by design. Only an individual bond held from issue to maturity delivers the fully fixed stream the label describes, and it is a minority of what people hold under that heading.

The one thing the sleeve reliably does is change the shape of the whole portfolio, not eliminate risk. The instruments inside it carry credit risk and interest rate risk in different proportions, and a portfolio that swaps stock market risk for those risks has changed which risks it runs rather than standing down. How much to hold in the sleeve is the asset allocation decision, and it is answered there.

A statement or a plan menu sorts holdings into categories, and fixed income is one of them. To know what you own, read past the label to the specific instrument: an individual bond, a bond fund, a certificate of deposit, a Treasury bill, a money market fund or a stable value option. Each behaves differently, and the sleeve name is shared by all of them.

A hypothetical example of the gap between fixed income and fixed value. Sunil holds $50,000 in a bond fund inside the fixed income part of his portfolio. Over one year the fund distributes 4% of that value, which is $2,000 of income, exactly as the label suggests. Over the same year the fund's share price falls 5%, a decline of $2,500.

His total return for the year is $2,000 − $2,500 = −$500, or −1%. The income was real and arrived on schedule; the value still ended lower. Nothing went wrong, no issuer missed a payment, and the holding did precisely what a bond fund does. The name of the category is simply not a statement about the balance.

Pros

• Gives a household one word for the lending half of a portfolio, which makes a target mix easy to state and to check.
• The category is broad enough to cover the realistic options inside a workplace plan, where the menu is short.
• Payments arrive on a schedule, which suits spending that is already dated.
• Holdings in the sleeve have often behaved differently from stocks, which is what makes the split worth making in the first place.

Cons

• The label is convention rather than definition, so two firms can classify the same holding differently and produce different allocation figures.
• The name promises a fixed schedule of payments and says nothing at all about value, which is the single most common misreading.
• Several instruments inside it do not pay a fixed amount, including money market funds, bond funds and inflation-protected securities.
• Grouping a certificate of deposit with a long corporate bond under one heading hides differences in credit risk and price behavior that are larger than the differences between some stocks.