Fixed Income

What's included

The fixed-income category covers:

• Government bonds — Treasuries, municipal bonds, sovereign debt of other countries.
• Corporate bonds — investment grade and high yield.
• Mortgage-backed and asset-backed securities — pools of underlying loans packaged into tradable bonds.
• Certificates of deposit — bank-issued time deposits.
• Preferred stock — though technically equity, preferred stock has bond-like characteristics.
• Money-market instruments — Treasury bills, commercial paper, repurchase agreements.
• Bank loans — syndicated and other loans, sometimes traded.
• Annuities — fixed annuities provide bond-like income streams.

Why fixed income matters

Three primary roles in a portfolio:

• Income. Bonds pay regular coupons; predictable cash flow useful for retirees and others needing steady income.
• Capital preservation. Higher-quality bonds preserve principal more reliably than equities. Treasuries are the closest thing to risk-free in nominal terms.
• Diversification. Bonds historically move differently from stocks, particularly during equity bear markets when investors flee to Treasuries.

The 2022 episode (stocks and bonds both falling sharply) was a notable exception driven by rapid rate hikes. The historical diversification pattern reasserted in subsequent years.

Yield vs. credit risk

Two main risk dimensions:

• Interest-rate risk — bond prices fall when rates rise. Long-duration bonds are more sensitive.
• Credit risk — risk of issuer default. Highest for high-yield corporates and emerging-market sovereigns.

Treasuries have minimal credit risk but full interest-rate risk. High-yield corporates have significant credit risk and modest rate risk (short duration usually). Investment-grade corporates fall between.

How most investors hold fixed income

Most retail investors hold fixed income through:

• ETFs — AGG, BND, IEF, TLT, LQD, HYG, MUB, etc. Diversified portfolios of hundreds or thousands of bonds.
• Mutual funds — actively or passively managed bond funds.
• Target-date funds — gradually shift toward fixed income as retirement approaches.

Direct ownership of individual bonds is more common at higher wealth levels and in specific situations (TIPS for inflation hedging, Treasury ladders for cash management).

Bond fund vs. individual bonds

A common confusion: bond funds and individual bonds behave differently:

• Individual bond held to maturity returns face value plus all coupons; price moves between issuance and maturity don't affect the eventual outcome (assuming no default).
• Bond fund never matures; it perpetually rolls into new bonds. Net asset value moves with rates; you can lose money on a bond fund even if no underlying bond defaults.

For investors with specific funding dates (mortgage payment, college tuition), individual bonds matched to the date are arguably safer than bond funds. For general fixed-income exposure, bond funds offer convenience and diversification at the cost of sustained rate sensitivity.

What 2022 taught

The 2022 fixed-income drawdown (long Treasuries down 30%+, AGG down ~13%) was the worst bond year in decades. Lessons:

• Duration matters. Long-duration bonds were destroyed; short-duration handled rates well.
• Bond-stock correlation isn't constant. Both can fall together when both are sensitive to the same shock (rapid rate hikes).
• Real rates can move dramatically. TIPS, often promoted as inflation hedges, also fell sharply because real rates rose.
• Bond funds suffer in rising-rate environments. A 7-year duration fund can drop 7% on a 100bp rate move. Sustained rate cycles produce sustained drawdowns.

Where fixed income fits today

After 2022's repricing, fixed income offers more attractive yields than it has in years:

• Treasury bills at 4-5% — first time in 15 years offering real yields.
• Investment-grade corporates at 5-6% — meaningful real returns.
• High yield at 7-9% — though credit risk is real and economic conditions matter.
• Munis at 3-5% federal-tax-free, equivalent to higher taxable yields.

For investors who fled fixed income during the 2010s zero-rate era, the case for re-allocating has strengthened materially. The boring "T-bills and equity-index funds" portfolio works much better at 5% T-bill yields than at 0.5%.