Bonds offer stability and income.

Investors often choose bonds to avoid market volatility and generate income, especially as they get closer to retiring. Government bonds such as municipal bonds and U.S. Treasurys provide income, but pay a lower yield when the Federal Reserve lowers interest rates for a longer period. Fixed-income investments provide a balance to stock portfolios during volatility and investors can choose from individual bonds, mutual funds or exchange-traded funds, says Daren Blonski, managing principal of Sonoma Wealth Advisors. "It's important to note that fixed-income tends to underperform stocks over the long run," he says. "Fixed-income investments should not be used as a replacement for stock investments." Here are seven types of fixed-income investments.

Bond ETFs or mutual funds

Choosing a single government or corporate bond can increase risk. Another approach is to add an ETF or mutual fund that owns many bonds, such as the Vanguard Long-Term Bond ETF (ticker: BLV). Investors receive a broader exposure with an ETF like JPMorgan U.S. Aggregate Bond ETF (JAGG) and investment-grade bonds, Blonski says. Investors seeking a higher return can select an actively managed mutual fund to seek an advantage, such as the Lord Abbott Short Duration Mutual Fund (LALDX). "The value of using a fund over an individual holding is that funds can provide an element of diversification," he says. "It's really important to understand the underlying assets you are buying."

Short-term bonds

Both corporate and government bonds have maturity dates that range from one year to as long as 30 years. When a bond matures, the issuer pays the principal or face value of the bond. A shorter maturity means the risk of interest rates rising is less and the investor receives a lower yield. Since the yield curve is flat, investors should stick with short-term bonds, says Charles Sizemore, a portfolio manager at Interactive Advisors. "When we see the 10-year Treasury yield get close to a 3% yield again, it might make sense to buy longer-term bonds," he says. "Until then, staying in T-bills or very short-term corporate bonds is the smarter move."

Preferred stock

Preferred stock is a hybrid investment that has characteristics of both common stock and bonds. Investors receive a coupon that specifies the yield, says Rohan Reddy, a research analyst at Global X ETFs. Preferred securities are sensitive to interest rates. When rates decline, preferreds rise in value and provide consistent dividend payments. They are typically issued by banks and insurance companies. Investors near retirement often seek more yield and some turn to preferred stock, since the yield tops most bonds, Reddy says. "Preferred stock dividends often come with favorable tax characteristics compared to bonds," he says. "A decent portion of preferred stock dividends are classified as qualified dividends, meaning dividends received by investors are taxed at their long-term capital gains rate."

Leveraged bond funds

Similar to stock funds and ETFs that use leverage to boost returns, bond funds have similar strategies. Be wary of bond funds that employ too much leverage because when "rates go the other way, they will be feeling some pain," says Ron McCoy, CEO of Freedom Capital Advisors. "An 8%, 10% or 12% yield is alluring to many and with the dip in rates this year, many have climbed higher in price," he says. Investors should be willing to accept to accept less yield in return for safety, McCoy adds. "The higher the yield, the more likely you will see volatility when things adjust."

Municipal bonds

Municipal bonds are issued by a city, state or government agency. The issuer agrees to pay the face value of the bond when it matures and interest. Municipal bonds can be free of taxes if you meet certain residency rules. With the potential tax benefit, it doesn't make sense to hold these bonds in a retirement account, but can they create tax-exempt interest income outside of a retirement portfolio, says Alex Chalekian, CEO of Lake Avenue Financial. A municipal bond mutual fund or ETF can also diversify the risk. "We tend to lean more towards the mutual fund option as we prefer active management of the bond holdings instead of an index," Chalekian says.

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Corporate bonds

Corporate bonds are one way for investors to lend money to a company and also earn a set yield along with the return of the principal amount. These bonds are ranked by ratings agencies on the likelihood of them defaulting. Experts typically recommend that investors stick with bonds that have an investment-grade rating, such as AAA, but no lower than BBB. Bonds can be downgraded before they mature, which makes them a riskier option in a portfolio, especially for people seeking income. Also, a company's stock price and corporate bond yield do not always have a correlation.

Government bonds

Government bonds include Treasurys and municipal bonds. They are at risk of interest rates declining. Investors who purchased longer-dated bonds that mature in 15 or 30 years face the most risk. Investors near retirement can avoid interest-rate risk by overweighting short maturity debt, says Derek Horstmeyer, an assistant finance professor at George Mason University. A risk of default should always be assessed by investors before adding a local or state bond to a portfolio. "Treasurys are a good place to invest money that you need better returns than you can get on cash, but also want to minimize the risk of loss," Blonski says.

Types of fixed-income investments:

-- Bond ETFs or mutual funds

-- Short-term bonds

-- Preferred stock

-- Leveraged bond funds

-- Municipal bonds

-- Corporate bonds

-- Government bonds

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