If you invest in a retirement plan, chances are you’ve got some sort of fixed income option in your account.
But the word “fixed” can refer to several types of investments, and these investments don’t all behave the same way. Depending on what’s available to you, you might be taking (or avoiding) certain risks, and there may be restrictions on how you can use your money. Knowing about the different types of fixed investments will help you understand what you’ve got and allow you to make a good decision.
Fixed Income
Fixed income is the broadest way to describe all of these investments described on this page. It’s more like a category of investments than any particular investment. The idea behind fixed income investments is that they invest in “fixed income” instruments: investments that pay a fixed or predictable stream of income to investors. For the most part, those investments are bonds and cash-like investments, and the income coming out of them is interest income.
In your retirement account, you might have several fixed income investments, or you might only have one. Which types do you have (or what do you have if there’s only one option)? Let’s go over the basics of these investments.
Fixed Income Funds
Perhaps the easiest kind of fixed income investment to understand is a fixed income fund. That’s a mutual fund (or ETF) that invests mostly in bonds and other relatively safe investments. It should be less volatile than a stock fund, but you can still lose money – even in the safest bonds – especially if interest rates go up.
Fixed income funds can invest in a number of different things, so you’ll want to figure out how any given fund works. It might be a money market fund with a goal of keeping your principal investment stable, it might be a short-term bond fund with a goal of earning a little interest with a small amount of risk, or it could be a junk bond fund with a goal of high returns (and not much concern for stability). The best way to understand what you have is to research each fund: find a description of the fund and read the prospectus. Websites like Morningstar.com might provide an analysis of the fund, and you can even get some hints on how risky a fund is by looking at its performance.
Fixed Account
A fixed account is a different type of fixed income investment. Fixed accounts are typically offered as part of an insurance contract (you might not realize it, but your retirement account might actually live inside of an insurance contract).
Fixed accounts are not mutual funds. With a mutual fund, your account performance is tied to the performance of the investments in the fund: if those investments gain or lose value, your account balance will follow along in sympathy. But with a fixed account, you’re separated by another layer. The insurance company invests your money but your account value doesn’t change. Their account value might change, but they keep your account value stable (fixed accounts are sometimes referred to as “stable value” funds).
When you use a fixed account, the insurance company usually just tells you how much you’re going to earn. They might say that you’ll earn 1.5% over the next year, for example. Assuming they don’t go belly-up, that’s what you’ll get. With a mutual fund, on the other hand, there’s no telling how much you’ll earn – your returns depend on how things go in the markets.
As you might imagine, fixed accounts are less risky than fixed income funds: your account balance doesn’t fluctuate, so a fixed account is a cash-like investment. However, there’s no such thing as a free lunch. Fixed accounts may have restrictions on taking money out: you might not be able to pull your funds out of a fixed account, or there may be a fee to pay if interest rates have been rising.