Fixed-Income Investments Explained - NerdWallet (2024)

What is a fixed-income investment?

Fixed-income investment products are considered by many to be key parts of a diversified portfolio and are a popular choice for beginner investors.

Often thought of as a less-risky option than some other asset classes, fixed-income investments and securities guarantee the return of your principal amount, plus a set amount of interest, either during or at the end of the term you agree to hold them.

Types of fixed-income investments

Not all products in this sector are created equal. Here’s a look at the different types of fixed-income investments and how they’re structured.

• Bonds
• Guaranteed investment certificates (GICs)
• Money market instruments

Bonds

Bonds are essentially a loan to the bond issuer (a government or company) for a set time, called a term. In exchange, your principal amount and interest payments from the issuer are guaranteed, either during or at the end of the term.

Types of bonds include

• Government of Canada bonds, including Canada Savings Bonds
• Provincial and municipal bonds
• Investment-grade corporate bonds
• High-yield bonds
• Stripped bonds (“strips”)
• U.S. Pay bonds
• Mortgage-backed securities

A fixed interest rate is set when you buy the bond. The rate you receive (called the coupon rate) is based on factors like the Bank of Canada’s interest rate and the length of your bond term. Terms to maturity can range anywhere from one day to 30 years.

For example, suppose you invest the minimum required $5,000 in a five-year Government of Canada bond paying 2% interest a year. In that case, you’ll receive $50 interest payments twice a year for a total of $500 in interest over the term. You’ll receive your full $5,000 principal back when the bond matures.

With many types of bonds on the market, it is important to note that each bond is designed differently. The interest rate you receive, the minimum investment requirement and the risk profile will vary depending on the type of bond you buy.

One way to assess the quality of a bond is through its rating, a score assigned by independent agencies that evaluate the bond’s credit quality and risk of default. Ratings range from AAA, the highest rating, to D, which means the bond is considered to be in default.

Guaranteed investment certificates (GICs)

A GIC is a loan to your financial institution for a set term: usually between one and five years for a long-term GIC or as little as 30 days for a short-term option. The bank agrees to pay you back your money at the end of the term, plus a fixed or variable interest rate. GICs can also be market-linked, giving you the potential to earn more interest if the market rises.

Some GICs may pay interest regularly or in full when it reaches maturity. GICs can also be cashable during the term or non-redeemable. In general, the longer the term of your GIC, the higher the interest rate offered. Non-cashable GICs also usually offer investors higher returns than those that are redeemable before maturity.

GICs can be held in registered accounts, such as tax-free savings accounts (TFSAs) and registered retirement savings plans (RRSPs).

Money market instruments

Money market instruments are short-term (up to 12 months) investments that provide a fixed rate of return when held to maturity and give investors the option to access their money during the term.

Money market instruments can include

• Federal and provincial treasury bills
• Commercial paper
• Bearer deposit notes and bankers’ acceptances
• Money market funds that invest in these products, including money market exchange-traded funds (ETFs)
• Fixed income funds and securities

Canadian fixed-income funds can come as mutual funds and fixed-income ETFs. These products bundle investment-grade fixed-income securities — such as bonds or any of the investment options listed above — into a single basket.

Pros and cons of fixed-income investments

Pros

Fixed-income investments generally carry a lower risk than equities, as they guarantee your initial investment — especially when you’re holding high-quality bonds with a high credit rating.

Fixed-income products are a helpful tool for diversification and are often used to protect against the market’s volatility since bond values have a low correlation to stock values.

If you’re just learning how to start investing, fixed-income options are a safe place to start as they also generally provide a higher return than leaving your money in cash and some offer investors a regular income.

Cons

The prices of bonds are often inversely tied to interest rates (when rates go up, bond prices go down), so if you sell your investment before maturity, you will be subject to the current market value.

As they’re considered more conservative investments, fixed-income products often offer lower returns than other asset classes, such as equities, when the market is performing well.

When held in non-registered accounts, any interest earned on fixed-income products such as bonds and GICs is taxable as regular income at your marginal tax rate.

Inflation is another concern for investors interested in fixed-income products. For investors to turn a profit with fixed-income investments, the rate of return on that product must match and exceed the rate of inflation — which may be especially challenging during periods of high inflation. If it doesn’t, investors may actuallylosemoney on their principal investment.

Alternatives to fixed-income investments

For Canadians who aren’t ready to dive into the fixed-income market, a high-interest savings account may be an alternative that provides a higher interest rate than your regular savings account.

You’ll also be able to access your funds more easily than with a non-redeemable GIC that locks away the principal amount invested until its maturity date.

Fixed-income vs. equity

Fixed-income and equity products represent separate asset classes with different risk-and-return profiles. Equity investments, such as shares and securities traded on stock exchanges, can offer higher rates of return for investors but carry more risk than fixed-income investments. A balanced investment portfolio has a mix of both asset classes.

Investors interested in pursuing a hybrid approach might look into preferred shares, which have fixed-income and equity characteristics — they provide fixed payments like a bond but also have a share price and are listed on an exchange.