Fixed income refers to debt securities that provide regular, predetermined interest payments until they mature, at which point you're paid back your principal amount. The term length can vary widely, from a few weeks to 30 years or more. For fixed-rate securities, the interest rate stays the same over the term.
Fixed-income investments can help diversify a portfolio and may reduce volatility by providing relatively steady interest payments during equity-market fluctuations. They can also be used as a source of income if you need to access funds but don't want to sell investments — one reason fixed-income products feature prominently in retirement portfolios.
Types of fixed income
The main types of fixed-income investments in Canada are bonds, Treasury bills (T-bills), guaranteed investment certificates (GICs), and money market funds. Each varies in structure, term length, quality, and risk level.
Bonds
Bonds are the most common type of fixed income. They work as loan agreements between issuers and bondholders:
Who issues them: Federal, provincial, and municipal governments; corporations; not-for-profits; and agencies.
How they work: Issuers pay a set interest rate over the bond's term and repay the principal at maturity.
Treasury bills
Also called T-bills, these notes are very short-term Canadian government debt obligations backed by the full faith and credit of the Government of Canada.
Guaranteed investment certificates (GICs)
GICs, which are only available in Canada, offer a secure way to invest your money and earn interest income. Like the name says, your money and the interest earned is guaranteed to return to you at the end of the term. GICs are typically offered at terms of between 30 days and 5 years, though longer terms of between 7 and 10 years are also available.
Money market funds
Money market funds are mutual funds that invest in high-quality, highly liquid interest-paying securities like short-term government bonds, T-bills, and commercial paper.
Key characteristics:
Returns: Often comparable to, and sometimes higher than, a savings account, but not guaranteed.
Liquidity: You can typically access your money at any time.
Variable income: Unlike many other fixed-income investments, you generally can't lock in a specific rate; yields fluctuate with the interest-rate environment.
How to invest in fixed income
You can invest in fixed income through individual bonds, funds and exchange-traded funds (ETFs), or GICs. The right choice depends on how much money you have to invest and how hands-on you want to be.
Individual bonds
You can purchase specific bonds issued by governments or corporations through a brokerage. This approach offers precise control over maturity dates and interest payments.
Trade-offs to consider:
Capital requirements: Often require a larger upfront investment to diversify properly.
Complexity: The bond market can be less transparent and harder to navigate than the stock market.
Funds and ETFs
Bond mutual funds and ETFs pool money from many investors to buy a diversified basket of fixed-income securities. This is often the most accessible route for everyday investors.
Key features:
Instant diversification: You can get exposure to many bonds with a single purchase.
Professional management: A manager handles buying and selling in exchange for a management fee.
Buying GICs
For those looking for a high level of security, GICs can be purchased directly from banks and other financial institutions. They are simple to understand and your principal is protected, but your money is typically locked in for the duration of the term.
Key elements of fixed income
Fixed-income securities have two defining characteristics: contractual interest payments and a fixed maturity date when your principal is returned.
Your yield (how much interest you earn) depends on two main factors:
Interest-rate environment: when rates rise, new GICs and bonds pay higher interest; when rates fall, they pay less
Credit quality: issuers with lower credit scores must offer higher interest to attract investors
For bonds specifically, the interest rate varies by issuer. Bonds issued by the Government of Canada and U.S. Treasury securities pay some of the lowest rates because both institutions are so stable that these bonds are often considered to have very low credit risk.
The maturity date is when your principal is paid back and the investment ends. This date significantly affects the investment's risk and return profile.
Longer-term fixed income (bonds with 10- to 30-year maturities) typically offer higher interest rates to compensate for locking up your money. However, longer duration means greater exposure to inflation and interest rate changes.
Money market funds are slightly different: the underlying investments do have maturity dates, but the fund manager continually invests in newly issued short-term debt so the fund itself does not mature.
Benefits of fixed income
Fixed income offers three main benefits: safety, more consistent income, and portfolio diversification. Many investors use fixed income to help balance the higher volatility that can come with equities.
Safety: Investors may receive their principal back at maturity, along with interest, if the issuer does not default. Government bonds and investment-grade corporate bonds are generally less volatile than stocks.
Income generation: Most fixed-income products pay interest semi-annually or annually (and some pay monthly or quarterly), which can provide more predictable cash flow.
Diversification: Fixed income is often less volatile than equities, which can help smooth returns. Holding a mix of durations and credit qualities can add further diversification.
Risks of fixed income
Fixed-income investments face five main risks: interest rate changes, inflation, credit risk, liquidity constraints, and tax inefficiency. While generally lower-risk than stocks, these factors can still influence their value.
Interest rate changes: When rates rise, existing fixed-income prices may fall because their income stream can be less competitive. Longer-term bonds are typically more sensitive to rate changes. You can help manage this risk through laddering (holding bonds with staggered maturity dates). Price declines only become realized losses if you sell before maturity.
Inflation: Because interest payments are fixed, their purchasing power can erode if inflation rises. Longer-term fixed income is typically more exposed to this risk.
Credit risk: If economic conditions weaken, bonds from lower-rated issuers may fall in value. High-yield bonds can sometimes experience declines similar to equities.
Liquidity: Some bonds trade less frequently, which can make them harder to sell quickly. Bonds from downgraded issuers can be especially difficult to sell.
Taxation: Bond interest is generally taxed as income at your marginal rate, which may be less tax-efficient than capital gains or eligible dividends. Some investors hold fixed income in a Registered Retirement Savings Plan (RRSP) or Tax-Free Savings Account (TFSA).
In Canada, GICs have specific liquidity considerations:
Non-redeemable GICs: Typically offer higher rates, but you generally can't access funds before maturity without a penalty.
Redeemable GICs: Typically allow earlier access to funds, but the interest rate is often lower.
Fixed income vs. equities
The fundamental difference between these two asset classes comes down to ownership versus lending.
When you buy equities (stocks), you are purchasing a small piece of ownership in a company. Your potential returns come from the company's growth and profits, which can be substantial, but you also share in the risk if the company struggles or fails. There are no guarantees.
When you buy fixed income, you're lending money to an issuer (such as a government or corporation) for a set period. In return, they are contractually obligated to pay you interest and return your principal. The upside is generally limited to the interest you receive, and many high-quality fixed-income investments have historically been less volatile than equities—though risk varies by issuer and term.
Are fixed-income investments right for you?
Fixed income can play a role in almost any portfolio. The amount you should hold depends on three key factors: your timeline, risk tolerance, and income needs.
Your timeline
If you need the money in the next few years — perhaps for a down payment on a home or upcoming tuition fees — the stability of fixed income is often a better fit than the stock market. Short-term bonds or GICs can help ensure the cash is there when you need it.
Your risk tolerance
If watching your portfolio value swing wildly keeps you up at night, increasing your allocation to fixed income can help smooth out the ride. While returns may be lower over the long run, the reduced volatility can make it easier to stick to your plan.
Your income needs
If you are retired or approaching retirement, you may no longer be focused on aggressively growing your wealth. Instead, the regular interest payments from fixed income can provide scheduled cash flow to help cover living expenses.
