Fixed income investments: Pros, cons & how they affect your portfolio

The world of investing makes many paths available, and knowing where to put your money can be challenging. As you build long-term financial strategies for you and your family, fixed income investments can be a sound option, offering stability and predictable returns.

Fixed income investments are securities that provide a regular income in the form of interest payments. These investments come in several different forms, including bonds, certificates of deposit (CDs) and Treasury inflation-protected securities (TIPS). They are typically less risky than other types of investments, such as stocks and commodities, making them a good choice for conservative investors.

Let's take a closer look at some examples of fixed income investments.

Bonds are essentially loans made to organizations or governments. The borrower agrees to pay back the loan, plus interest, over a set period. Bonds can be bought and sold on the secondary market before they mature, which creates some potential for capital gains or losses.

CDs are deposits made to banks or credit unions for a set period, often with higher interest rates for longer terms. The depositor cannot withdraw the money during that predetermined period without incurring penalties.

TIPS are a type of fixed income investment backed by the U.S. government. The investment principal is protected from inflation, so it maintains its value even if prices rise. TIPS pay a fixed interest rate that's adjusted in regular intervals based on the inflation rate. This makes them a good option for investors who are concerned about inflation.

Fixed income investments typically have a low level of risk because they provide predictable and steady returns. This makes them a popular choice among investors looking to preserve their capital rather than growing it rapidly. Many fixed income investments also carry relatively short terms, which means they may be less prone to market fluctuations than other types of investments. For example, bonds typically mature within five to 10 years, while CDs have terms ranging from three months to five years.

Fixed income investments offer several potential benefits, depending on your financial goals.

Some investments don't generate income until you sell them and receive capital gains. Fixed income investments, on the other hand, pay regular interest. This steady and predictable flow of income can be especially helpful for retirees looking to supplement their monthly income in retirement.

Adding fixed income investments to your portfolio can help diversify it and make it less risky overall.* These types of investments are not as heavily impacted by changes in the market compared to stocks, so economic recessions and political events have less of an impact.

Fixed income investments are also a strong way to preserve capital. While they typically offer smaller returns than high-growth investments, they tend to hold their value. For this reason, they may appeal to people close to, or in, retirement.

Since fixed income investments are well-regarded among investors, they generally can easily be liquidated for cash. If you need money or simply want to free up cash for another investment, you can usually sell your shares relatively easily.

Although fixed income investments tend to be less risky than other types of investments, there is still some inherent risk involved. These risks generally fall into four categories:

One of the most significant risks is inflation risk, which occurs when the interest payments on the investment do not keep pace with rising prices. This can erode the purchasing power of the investment over time.

Credit risk marks another potential issue surrounding fixed income investments. This occurs when the issuer of the investment is unable or unwilling to make interest or principal payments when they come due. For example, this could happen if the issuer experiences financial difficulties or declares bankruptcy.

Bond prices and interest rates have an inverse relationship. With fixed income investments, an increase in interest rates can cause the price of bonds to decline.

Liquidity risk is the possibility that an investor will not be able to sell an investment reasonably quickly at, or near, its current market value. This can stem from a number of factors, such as low trading volume or a volatile market.

Liquidity risk can be especially concerning with certain types of fixed income investments, such as individual bonds, since they're often not as liquid as other investments like stocks or mutual funds.

For example, an investor may not be able to sell a bond on the secondary market for the same price they paid for it. Similarly, if they want to cash out a CD before the maturity date, they may have to pay a penalty. This can make it difficult for investors to access the full value of their fixed income investments on short notice.

Staying aware of these risks can help you avoid potential pitfalls when investing in fixed income securities. By assessing your own comfort with risk and diversifying investments within your portfolio, you can manage your level of exposure to them.

Fixed income securities can offer investors stability and predictability in their portfolios, but it's essential to understand exactly how they may fit into your larger financial picture before deciding where to put your money. For guidance on this topic or other financial planning needs, connect with a local Thrivent financial advisor. They can help you determine if fixed income investments are right for your goals and help you navigate the full range of available investment options.