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Do You Really Need Fixed-Income Funds in Your 401(k)?

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When you are looking at the investment options for your 401(k), you might consider fixed-income funds. Though these funds are a somewhat niche option for 401(k) investing, they can be useful in specific circumstances, such as if you are close to retirement and need low-risk assets to preserve your capital.

In this article, we’ll explain what fixed-income funds are and how to use them toward your investing goals.

Key Takeaways

  • Fixed-income funds are low-risk investments investors can use for their 401(k). 
  • If you are focused on growing your portfolio, these funds may not ideal because other asset types have greater potential for higher returns. 
  • Fixed-income funds are designed to generate regular, reliable returns.

What Are Fixed-Income Funds?

Fixed-income funds hold a portfolio of assets like bonds or other debt securities and provide fixed income, or regular payments. They are offered by banks and insurance companies, and have features in common with a certificate of deposit (CD), which is a savings account that provides fixed returns for a set period. These funds are designed to grow slowly with little risk and provide a predictable rate of return.

Fixed-income funds are much less volatile than stocks, but they also tend to provide a lower rate of return.

Fixed-income funds primarily hold government and corporate bonds with short- to medium-term maturities of about two to four years. These funds typically pays higher interest than a money market fund, which usually invests in fixed-income securities that are very liquid, such as cash or contracts with short maturities.

Other terms may refer to a fixed-income fund or a type of fixed-income fund include: “stable value funds,” “guaranteed investment contracts (GICs),” “capital preservation funds,” “principal protection funds,” “fixed interest funds,” “guaranteed funds,” or “stable interest funds.” 

Some types of these funds are also limited in their availability. For example, stable-value funds are generally only available via your 401(k), and even then some employers do not offer them to their plan participants. That means that you may not be able to purchase all types of fixed-income funds in an IRA account or your brokerage account.

Unlike with mutual funds, the share price of some fixed-income funds, such as stable value funds, will not change over time.

How To Use Fixed-Income Funds In Your 401(k)

Though there is generally a “fixed income” allocation in most target-date funds, for most people who are managing their own 401(k) fixed income funds have only a limited utility. Perhaps the best way to look at these funds is as a happy medium between cash and money market funds, which have low yields, and bond funds, which have higher risk and volatility.

Stable value funds are primarily useful for conservative investors and those with relatively short time horizons. If you are nearing retirement, these funds will provide income with minimal risk. They can also help to stabilize the rest of your portfolio, acting as a hedge against stock market volatility. 

On the other hand, if you can tolerate more risk and want to grow your portfolio aggressively, these funds may not be suitable for you. Over the long-term, they are unlikely to provide as high of return as stock funds. In general, most advisors recommend allocating no more than 6% to 15% of one’s assets into these funds, with the average allocation falling in the 13% range. How much you allocate will depend on your own investing goals and financial situation.

What Are Fixed-Income 401(k) Funds?

A fixed-income fund holds multiple fixed-income assets and pays a set rate of return over a certain period of time. These funds are composed of investment contracts issued by banks and insurance companies. 

Why Use Fixed-Income 401(k) Funds?

Fixed-income funds can help investors preserve capital while earning a modest return, so they are often ideal for people near or in retirement. Stable value funds provide liquidity and offer returns that are comparable to short-term bonds. 

How Safe Are Fixed-Income 401(k) Funds?

Fixed-income 401(k) funds are considered a safe investment. The chance of losing money or not receiving your expected returns is small compared to other investment types like stocks.

The Bottom Line

Fixed-income funds are considered a low-risk investment for helping you diversify your 401(k) from stocks. If you have a high risk tolerances, such as if you are decades away from retirement, these funds may not be ideal because they tend to provide lower returns. Your money has a greater potential for higher gains grow with other higher-risk investment types like stocks or regular mutual funds.

However, for investors with a low risk tolerance, fixed-income 401(k) funds can be an ideal asset to preserve capital and provide predictable income.

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