Looking for a Steady Stream? Consider Fixed-Income Mutual Funds

If you’re considering fixed-income investments as a way to diversify your portfolio and target a steady stream of income, you might want to give fixed-income mutual funds a look. Here’s what you need to know.

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Key Takeaways

  • Fixed-income mutual funds hold baskets of securities such as corporate bonds, Treasury securities, and municipal bonds
  • Compare expense ratios, management track records, minimum investment requirements, and other criteria to help you find funds that fit your objectives and risk tolerance

When it comes to portfolio allocation, most financial pros suggest devoting a portion to fixed-income investments—Treasury securities, corporate bonds, and such. But how do you decide which ones to buy? And how concentrated are you willing to be in any one security?

There are many different categories and products of fixed-income instruments to choose from, each with their own unique set of potential benefits and risks. If you’d like to spread your investment among many different fixed-income investments, you might consider fixed-income mutual funds.

Many Different Types of Fixed-Income Funds

Fixed-income mutual funds—commonly referred to as income funds—are a type of mutual fund that holds a basket of fixed-income securities such as government bonds, corporate bonds, international bonds (government and corporate), money market instruments, and in some cases, dividend-paying stocks.

Some funds may focus on a single category of fixed income (e.g., U.S. Treasury bonds or money markets) while other funds may mix and match categories.

Here are a few basic categories of fixed-income mutual funds to get a feel for what they offer.

Money Market Fixed-Income Funds

If you’re looking for steady income with almost no change in the value of your principal investment, then why not check out money market mutual funds? The yields may be lower than other fixed-income funds, but in exchange, their net asset values hardly change at all, hovering at or near $1 per share, almost like a higher-yielding savings account but in a mutual fund.

Money market mutual funds invest in short-term, high-quality debt and cash equivalents that are often exchanged between large corporate and financial institutions. Comprised of short-term debt, money market instruments tend to be less risky than their longer-term counterparts. But because you’d be investing in a mutual fund holding these loans, and not directly in the loans themselves, your investment is not FDIC insured as it would be if you had invested directly into the money market.

Government Bond Fixed-Income Funds

Interested in receiving income payments from government debt? Many fixed-income funds invest in both federal securities (U.S. Treasuries) and municipal bonds (aka “munis”). Treasuries are debt instruments issued by the federal government while municipal bonds are debt instruments issued by a particular city, state, or municipality. One potential advantage to investing in these funds is that with some, your income stream may be tax-exempt on a federal and/or state level. But as with all mutual funds, if you sell your positions at a realized gain, then the profit you make is subject to capital gains taxes.

Corporate Fixed-Income Funds

If you’re looking for higher yield, you might want to consider an income fund in the corporate bond category. Bear in mind, however, that yields often correspond with a company’s creditworthiness. So a higher yield typically means a riskier bond. Company bonds considered “investment grade” are less risky, but their yields tend to be lower. Bonds issued by companies that are financially distressed or have poor credit ratings—the lowest being “junk bonds”—tend to offer higher yield as a means to attract investors.

Whittling It Down? Screen & Compare

TD Ameritrade clients can screen for a number of criteria such as performance, ratings, risk, fees, expense ratios, and more. Just log in and under the Research & Ideas tab, select Screeners > Mutual Funds, and choose your criteria.

Or, if you have candidates in mind, do a side-by-side comparison of up to five fund symbols. Under the Research & Ideas tab, select Mutual Funds > Compare Funds.

But on the brighter side, investing in corporate bonds through a diversified income fund might minimize your risk should a particular company default on its debt obligations. So, instead of losing your entire principal, which can happen if you invest in a bond directly and it happens to default, you may just experience a drop in your fund’s net asset value (NAV). Although this doesn’t guarantee you’ll be protected from loss, spreading your fixed-income eggs among several baskets might be the safer and more prudent choice.

International Fixed-Income Funds

Like the broader market, the global economy also undergoes cyclical changes. And like individual stocks and sectors, countries, currencies, and the fixed-income market also “rotate” in economic strength. this is one reason you might want to consider diversifying your fixed-income prospects across the globe.

Investing in international fixed-income funds is one way to gain exposure to foreign government and corporate bond income. You’ll also be diversifying your portfolio with assets denominated in currencies other than the U.S. dollar. Bear in mind that with international exposure comes exchange rate risk. Currencies fluctuate, so money invested abroad will rise and fall as foreign currencies rise and fall relative to the dollar.

Dividend-Bearing Mutual Funds

Though not traditionally considered part of the fixed-income family, mutual funds holding dividend-paying stocks do target income. Comprised of stocks, this also means their net asset values tend to be more volatile than most other income funds, just as the stock market tends to be more volatile than the bond market over the long term. While the dividends may be taxed as ordinary income or capital gains (be sure to check the fund’s prospectus), any profits you generate by selling shares at a gain will likely be subject to capital gains taxes. And remember, dividends aren’t guaranteed; even a company with a long history of dividends and dividend growth could at any time cut, or even eliminate, its dividend.

How to Target Income with Mutual Funds

Now that you have a clearer picture as to the various assets that fixed-income mutual funds hold, how might you go about finding and comparing these funds? In other words, how might you find the right fund to match your income goals?

One way to start is by checking out a mutual fund category menu or a more general mutual fund list. Once you’ve decided which category of fixed-income fund you’re targeting, compare these and other characteristics:

  • Management fees and expense ratios: Some income funds cost more than others. Try to figure out the total annual cost for a given fund and compare them across the board with similar funds. Once you see the bigger picture in terms of expense, you might want to compare the funds’ costs against their past performance (track record) to get a sense as to which fund might better suit your objectives.
  • Track record: It’s important to understand that past performance doesn’t necessarily guarantee future results, as the market, economy, and every asset within it undergoes cyclical changes. Nevertheless, a fund’s track record might still be the most accurate means to see how the fund has performed over time across various market cycles.
  • Minimum investment requirements: Can you afford to buy into a given fund? Each fund has a different minimum investment, so be sure to research this thoroughly to find the fund that best meets your budget.
  • Recurring purchase programs: This is more of a brokerage feature than a fund offering and allows you to invest in a given fund (or funds) on a weekly, semi-monthly, monthly, or quarterly basis. It can be helpful to build exposure to this part of your portfolio over time.

Fees and taxable events vary across funds. Be sure to read the prospectus carefully when you comparison shop for cost savings. Make sure the underlying securities and overall fixed-income fund categories match what you’re looking for.

Remember, there is no sure-shot investment. But a well-diversified portfolio, which might include fixed-income investments, can help you pursue a steady stream of cash flow for discretionary spending, savings enhancement, or perhaps retirement income.

Carefully consider the investment objectives, risks, charges, and expenses before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.

Mutual funds are subject to market, exchange rate, political, credit, interest rate, and prepayment risks, which vary depending on the type of mutual fund.

Asset allocation and diversification do not eliminate the risk of experiencing investment losses.

Investing Basics: Mutual Funds
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Key Takeaways

  • Fixed-income mutual funds hold baskets of securities such as corporate bonds, Treasury securities, and municipal bonds
  • Compare expense ratios, management track records, minimum investment requirements, and other criteria to help you find funds that fit your objectives and risk tolerance
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