Finance
Fixed Income
Investments that promise a specific, scheduled stream of payments — most commonly bonds — as opposed to investments like stocks whose payouts aren't fixed or guaranteed in advance.
Definition
Fixed incomeis a broad category of investments that pay a predetermined, scheduled stream of payments to the investor — most commonly interest payments plus a return of principal at a set future date — rather than a payout that varies unpredictably like a stock's dividend or price. The most common form of fixed income is a bond: a loan made by the investor to a government or company, in exchange for those scheduled payments.
Why this exists
Per What an Interest Rate Fundamentally Is, lending money to someone else — giving up its use for a while, taking on the risk they might not pay it back — is compensated with interest. Fixed income investments are essentially that same lending relationship, formalized and standardized so it can be issued in large amounts to many different lenders at once, and often resold between investors before the loan is even repaid. A government or company that needs to borrow money issues a bond specifying exactly what it will pay, and when, and investors buy those bonds knowing upfront exactly what payment schedule to expect — hence "fixed" income.
This predictability is the whole point, and it's what distinguishes fixed income from investments like stocks. Per Risk & Return, riskier investments have to offer a higher expected return to attract investors — a stock's future price and dividends aren't promised or scheduled in advance, so stock investors are compensated with, on average, higher expected returns for bearing that uncertainty. A bond's payments, by contrast, are specified upfront and don't change based on how well the issuer's business happens to do that year, barring the issuer running into serious trouble — which is why fixed income investments generally carry lower expected returns than stocks: investors are trading away some upside in exchange for that certainty.
"Fixed income" is really an umbrella term — government bonds, corporate bonds, and other similarly structured debt instruments all fall under it — but the underlying idea across all of them is the same: money lent today, in exchange for a defined, scheduled series of payments, rather than an open-ended share of however a business happens to perform. See Bond Valuation for how a bond's set schedule of payments translates into a price today.
Worked example
Compare buying stock in a company versus buying one of its bonds. Buying stock means your return depends entirely on how the company performs — it could soar, or it could pay you nothing at all. Buying one of the company's bonds instead means you're promised, say, $50 twice a year for 10 years and $1,000 back at the end, regardless of how well or poorly the company's stock performs, as long as the company doesn't default. One accepts the company's performance risk for higher potential upside; the other accepts a known schedule for a lower, more certain return.
Common misconceptions
“Fixed income means risk-free.”
Fixed income issuers can still default, and factors like inflation can erode the real value of fixed payments. "Fixed" describes the payment schedule, not a guarantee of getting paid, or that the payments will be worth as much as expected.
“All bonds pay the same, low, predictable return.”
Yields and risk vary enormously across fixed income — a government bond from a stable country and a bond from a financially shaky company are both technically "fixed income," but carry very different risk and return.
“Fixed income only means bonds.”
Bonds are the most common form, but other debt instruments can also fall under the fixed income umbrella if they follow a similarly fixed, scheduled payment structure.
Also in the Glossary: Fixed Income