Fixed Income

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Definition of Fixed Income:

Fixed income refers to an investment or compensation that pays a fixed amount on a fixed schedule.

Detailed Explanation:

Individuals who earn the same nominal compensation have a fixed income. An individual owning a pension that pays $3,000 each month receives a fixed income. Examples of investments that provide investors a fixed income include bonds, most annuities, and certificates of deposit. 

Inflation hurts individuals who are on a fixed income because their incomes rise less than the inflation rate. Many retired individuals must rely on a stable income, so they invest in safe assets such as bonds and certificates of deposits that pay a fixed amount. Many pensions pay the same nominal amount each month. As prices increase, they are able to purchase fewer goods and services. Social Security payments in the United States were fixed until 1975 when Congress voted to provide social security recipients annual increases tied to inflation. Many long-term employment contracts have a cost of living adjustment (COLA) to protect the beneficiaries against inflation. The payments automatically adjust when the consumer price index increases. Tax tables are also now adjusted for inflation in United States.

Low inflation normally benefits individuals on a fixed income. However, reinvesting can be a challenge when inflation is unusually low. Interest rates remained at very low levels between 2010 and 2016. Where should someone relying on a stable income reinvest that is safe, but provides an adequate income stream? Frequently investors boost their income by either investing in riskier investments or buying longer term securities. Both carry additional risk. The riskier investment has a greater probability of default. The longer term investment ties money up for a longer period. If interest rates rise, the investor is stuck with the investment unless the security is sold. But if it is sold, it will probably be sold at a discount.

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