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April 11, 2022 — 12 min read

How to make fixed income part of your investing strategy

Josh Pigford


Josh Pigford

Fixed income securities are a type of debt instrument under which the borrower or issuer is obligated to pay the purchaser/holder of the fixed income instrument a fixed amount of money on a set schedule.

They generally provide regular, consistent returns at periodic intervals that are paid out to the investor and promise to repay the principal amount to the investor at maturity (duration of the loan). The most common fixed-income instruments are government and corporate bonds, which use the investors’ capital (acquired from selling the bonds to investors) to finance their operations.

Fixed income instruments are generally less risky when compared to stocks and provide a stable income in the form of interest at regular time intervals.

Types of fixed income instruments

There are a variety of financial instruments that you can choose from when it comes to generating fixed income for your retirement or for financing a particular goal. The major ones you can look at are:


Bonds are financial instruments in which you as an investor offer your investment as a loan or debt to an issuer. The issuer (a government or a company) promises to repay your investment principal and a fixed amount of interest as a coupon at regular intervals.

The different types of bonds in order of ascending risk/reward profiles (low to high risk/reward) are:

Treasury bills and Treasury notes:

T-bills (not the same as T-Bonds) are short-term U.S. government-backed debt obligations that the treasury department issues. They have a maturity of one year or less.

T-notes offer a fixed rate of interest semi-annually till maturity, and they have a maturity of 2, 3, 5, 7, and 10 years. The longer duration T-notes offer higher interest than the short term T-notes as the default risk (however small) increases over more extended periods.

Treasury Inflation-Protected Securities (TIPS):

TIPS is a security that the U.S. government issues to protect investors from reducing purchasing power due to inflation. If you buy TIPS and inflation increases, the interest or yield doesn't increase. However, the price of the TIPS adjusts to maintain the actual value. TIPS provides greater investor protection than short-term bonds and similar instruments when interest rates rise.

Fixed-income mutual funds and ETFs:

Fixed-income mutual funds and ETFs (exchange-traded funds) by Vanguard and similar groups like Charles Schwab, Fidelity, etc., offer investors a diversified portfolio of fixed-income instruments (mainly bonds). A diversified fixed-income portfolio via a mutual fund or ETF can eliminate company or corporation-specific risks. Hence, the only risk you have to endure is the market risk.

Investing in these funds also reduces the complexity of picking and choosing fixed-income instruments to add to your portfolio and provides you with an all-in-one solution. However, investors have to pay a small management fee for these conveniences. Nowadays, several major groups like Vanguard offer funds with small management fees (expense ratios) of 0.035% of assets annually. But other groups and companies will charge higher fees, so be sure to do your due diligence when looking into them.

Certificates of deposit (CD):

A CD is a fixed-income instrument that helps you as an investor earn a little more interest than a bank savings account. C.D.s are generally offered to investors by financial institutions and have maturities of less than five years.

Risks of fixed-income instruments

There are different types of risks associated with holding fixed income instruments. We will cover some of the significant risks below to understand better the risks associated with these instruments.

Comparing Stocks and Fixed Income

From April 2007 to February 2022, the stock market fund (VTI) has given an annual return (calculated by CAGR) of 6.95% (due to an initial fall in stock prices due to the financial crisis), and the bond market fund has given an annual return of 3.37% (with significantly lower volatility). From the graph, we can also infer that bonds don't fall drastically during moments of crisis, such as the 2008 financial crisis (see below).

VTI vs BND - Cumulative returns.png

In the graph below (data and analysis here), we can see the month-to-month fluctuations in the prices of stocks (red line) and bonds (blue line). We have used the adjusted prices (including dividends) of the Vanguard Total Bond Market Index Fund ETF Shares (BND) for the bond prices. BND provides the investor exposure to the entire U.S. bond market via a broad, market-weighted bond index that excludes inflation-protected and tax-exempt bonds.

For the stock prices, we have used monthly price data of the Vanguard Total Stock Market Index Fund ETF Shares (VTI), which tracks the performance of the CRSP U.S. Total Market Index, which contains nearly 4000 companies across mega, large, small, and micro capitalizations, representing almost 100% of the U.S. investable equity market.

The graph shows that stock prices fluctuate much higher/lower than the mean, even monthly. This analysis shows that stocks are much more volatile than bonds. Your portfolio will fluctuate more (more volatile) as your allocation to stocks increases and become less volatile as your allocation to bonds increases.

Monthly volatility (VTI vs. BND):

Volatility - bonds vs stocks.png

Daily volatility (VTI vs. BND):


(More granular data and analysis here.)

Performance analysis of bond funds

The most significant portion of your fixed-income portfolio will likely consist of various bonds, so taking a deeper dive into the performance of different bond funds can help you make a better decision on what bonds you wish to hold.

Below you can see the returns (CAGR), volatility, and derivatives of various bond ETF funds catering to different types of funds like Treasury bonds (T-bonds), Corporate bonds, High-yield bonds (Junk bonds), and Total bond market funds.


(You can find the complete data and analysis here.)

Below are the cumulative returns of the various bond fund ETFs including the Total Bond Market Fund ETF (BND), 20-year Treasury Bond ETF (TLT), Long-Term Corporate Bond ETF (VCLT), and the High-Yield Corporate Bond ETF (HYG).

Performance of Bond funds - Cumulativ...

Bond portfolio strategy

A simple strategy you can follow while building up your bond portfolio is using a total bond market index fund or ETF as a core portfolio where you invest 70-100% of your bond allocation. Based on your risk tolerance, you can also compliment your core portfolio with a satellite portfolio (0-30% allocation) containing various instruments such as TIPS, high-yield bonds, T-bills, C.D.s, etc.

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