What Is a Fixed Term Investment and How Does It Work?

Fixed-term investments allow money to grow by locking it in for a set period with a predetermined return. They appeal to individuals and businesses seeking stable earnings without the volatility of stocks or other market-driven assets. These investments include bank deposits, bonds, and structured financial products, each offering different risk and return levels.

Understanding their structure, tax treatment, and renewal options is crucial before committing funds.

Key Terms

Fixed-term investments require funds to be committed for a specific duration, known as the “tenor” or “maturity period,” which can range from months to years. Shorter terms generally yield lower returns, while longer commitments offer higher yields to compensate for the locked-in capital.

The rate of return is a key feature, often expressed as an annual percentage yield (APY) or coupon rate. Some investments offer a fixed rate, ensuring predictable income, while others have a variable rate tied to benchmarks like the Secured Overnight Financing Rate (SOFR) or government bond yields. Fixed rates provide stability, while floating rates introduce exposure to interest rate fluctuations.

Liquidity is another consideration. Unlike stocks or mutual funds, which can be sold at any time, fixed-term investments often impose penalties for early withdrawal, such as forfeited interest or percentage-based fees. Some instruments, like certificates of deposit (CDs), allow early withdrawal under specific conditions, usually at a cost.

Common Structures

Fixed-term investments come in various forms, each suited to different financial goals and risk tolerances.

Certificates of deposit (CDs), offered by banks and credit unions, require a lump sum deposit to remain untouched for a set period, earning interest at a predetermined rate. CDs issued by FDIC-insured U.S. institutions are protected up to $250,000 per account holder, making them a low-risk option.

Corporate and government bonds let investors lend money to entities in exchange for periodic interest payments and principal repayment at maturity. U.S. Treasury notes carry lower risk due to government backing, while corporate bonds offer higher yields to compensate for credit risk. Issuer creditworthiness, rated by agencies like Moody’s or Standard & Poor’s, influences the interest rate.

Structured deposits combine fixed-term deposits with derivative components, linking returns to stock indices, commodities, or foreign exchange rates. While they offer higher earning potential, they also introduce market risk, making them suitable for investors comfortable with uncertainty.

Tax Treatment

Taxation depends on the investment type, investor’s jurisdiction, and how returns are classified—whether as interest income, capital gains, or dividends.

Interest from fixed-term deposits, such as CDs or savings bonds, is typically taxed as ordinary income in the year received. In the U.S., this means federal income tax rates from 10% to 37% in 2024, depending on the investor’s tax bracket. Some states impose additional taxes, while others, like Florida and Texas, do not tax interest earnings.

Certain investments offer tax deferral. U.S. Series EE and I savings bonds allow deferring interest taxes until redemption or maturity, which benefits those expecting a lower future tax bracket. Municipal bonds provide another advantage, as their interest is generally exempt from federal income tax and, in some cases, state and local taxes if issued within the investor’s state.

Fixed-term investments in tax-advantaged accounts, such as traditional IRAs or 401(k)s, grow tax-deferred until withdrawal. Investments in a Roth IRA allow for tax-free qualified withdrawals if the account holder meets age and holding period requirements, maximizing after-tax returns.

Accounting Recognition

Fixed-term investments must be recorded according to accounting standards such as IFRS 9 or ASC 320 under U.S. GAAP, which govern classification and measurement. Depending on the entity’s intent and ability to hold the investment until maturity, these assets may be categorized as amortized cost, fair value through profit or loss (FVTPL), or fair value through other comprehensive income (FVOCI). Classification determines how changes in value and interest income are recognized.

Investments classified at amortized cost are initially recorded at purchase price and adjusted using the effective interest rate (EIR) method. This method accounts for stated interest payments and any premiums or discounts paid at acquisition, ensuring income reflects the true yield over the investment’s life. If a bond is purchased at a discount, the carrying amount gradually increases until it reaches face value at maturity, with the difference recognized as interest income.

Impairment considerations also apply, particularly under IFRS 9’s Expected Credit Loss (ECL) model, which requires assessing potential credit losses from acquisition. This forward-looking approach replaces the incurred loss model, requiring financial institutions and corporations to estimate defaults even if no actual loss has occurred. The ECL model applies a three-stage approach, with assets moving between stages based on changes in credit risk, affecting provisions.

Renewal Choices

Upon maturity, investors must decide whether to withdraw funds, reinvest in a similar product, or explore alternatives based on interest rates, liquidity needs, and financial goals.

Some investments, like CDs and certain bonds, offer automatic renewal, where principal and accrued interest roll into a new term unless the investor opts out. While convenient, this may not always be beneficial if market conditions have shifted or better opportunities exist.

For structured products and corporate bonds, renewal is not always an option, as issuers may not offer identical investments upon maturity. Investors must assess market conditions, including interest rate trends and credit risk, to determine whether similar instruments offer competitive returns. Some financial institutions offer laddering strategies, where investments are staggered across multiple maturities to balance liquidity and yield, reducing reinvestment risk.