The main goal of fixed-income investments is to provide income and to earn returns in excess of inflation. There are two different types of fixed-income assets: taxable bonds and tax-free bonds. Taxable bonds include U.S. Treasury bonds, corporate bonds, and U.S. government agency issues. Tax-free bonds include bonds issued by U.S. government agencies like Fanny Mae and Freddie Mac. Tax-free bonds may also be revenue bonds or general-obligation bonds and may be issued by state or local governments and agencies. Such bonds are generally exempt from federal taxes and may be exempt from state taxes as well.

There are several different types of fixed-income investment assets, including short-term bond funds. Short-term bond funds invest in bonds that mature in less than five years; these bonds are less vulnerable to interest-rate risk than long-term bonds. Although the return on these investments is not as attractive, these investments are generally considered to be appropriate for anyone who needs a dependable stream of income from interest or dividends.

Another fixed-income investment is intermediate bond funds, which have an average maturity of three to ten years; another option is long-term bond funds, which have an average maturity of ten or more years. These long-term bonds are much more vulnerable to interest rate volatility because the principal is at risk for a longer period of time.

Investing in bond mutual funds is very different from investing in individual bonds. Bond mutual funds allow you to buy and sell bonds before they mature; therefore, there are tax implications for investors (see the section on Investments 4: Bond Basics). Investing in a bond fund means you are buying a share of many different bonds in a changing portfolio rather than purchasing a single bond.

Income from fixed-income bond funds fluctuates as mutual fund investors buy and sell bonds. The market value of the fixed-income bond fund changes depending on whether investors are selling bonds at a loss or a gain; length of maturity also affects the income. If you look at the average maturity of the bonds in your bond fund, you will get a clearer picture of the volatility of that fund regarding interest-rate fluctuations. The longer the average maturity of the bonds, the more dramatically the principal will gain or lose value as the interest rates change.

The advantages of fixed-income assets include that they offer a greater potential for return than cash investments, although they involve greater risk. Fixed-income assets are also a good diversification tool for a long-term stock portfolio because bonds generally behave differently than stocks do. The disadvantages include that the returns on fixed-income assets have historically been lower than the returns on stocks. Fixed-income assets are very susceptible to interest-rate changes and other risks.

Generally, fixed-income assets are not good long-term investments by themselves because they do not provide enough growth to beat inflation over long periods of time. However, these assets should be one part of an overall diversified portfolio.