How Does a Guaranteed Interest Mutual Fund Work?

Mutual funds that guarantee interest are called fixed-income funds, or simply income funds. Fixed-income funds invest in bonds and other securities that provide guaranteed periodic interest payments to investors. Fixed-income securities have prices that are much more stable than stocks, so they are considered relatively safe investments for people who depend on investment safety, such as those who are retired or nearing retirement age.

Bonds are sometimes referred to as debt securities as they represent debt for governments or companies that issue them. When you buy a bond, you are essentially providing a loan to the issuer. In return, the issuer promises to pay back the price the bond was originally issued along with guaranteed periodic interest payments over the life of the bond.

Preferred stock is considered a hybrid investment. It is part stock and part bond. It is stock because preferred stockholders own interest in the company -- they are not merely loaning the company money like bondholders do. It is also like a bond because, it comes with guaranteed periodic dividend payments, much like bond interest payments.

Fixed-income funds offer several advantages to investors. First and foremost, they provide a steady stream of income for those who are living on a fixed income. Because they are mutual funds, they also offer investors a well diversified portfolio of investments, which helps reduce risk. Finally, fixed-income funds are managed by professional investment managers, who make all buy and sell decisions inside the fund for the owners.

No investment is risk free, and fixed-income funds are no exception. While the price of these funds is relatively stable, money held in them is vulnerable to inflation risk. This is especially true in a high inflationary environment, where spending power can erode much more quickly than money held in stock funds.