Fixed-Income Investing Risks

Fixed income investing can provide you with solid returns and a consistent paycheck. However, this type of investing also carries with it a fair amount of risk. Here are a few of the different types of risks that you will need to be aware of if you plan on getting involved in fixed income investing.

Interest Rate Risk

Interest rate risk is perhaps the biggest risks that you will have to worry about when you are getting involved with this market. Bonds are subject to interest rate risk and they share an inverse relationship with market interest rates. Since they provide investors with a fixed interest rate, they are going to be sensitive to changes in the market interest rates. If the market interest rates increase, the value of your bond is going to decrease. If interest rates increase, the value of your bond is going to go up. If you plan on holding the bond until maturity, this is really not going to matter. You will get what you have been promised and then cash in the bond. However, if you plan on buying and selling regularly, you are going to have to worry about market interest rates.


Another problem that you will have to worry about is inflation. Inflation can negatively impact the returns that are provided by bonds. Most of the time, the returns that bonds provide are modest anyway. Then when you take out 2 to 4 percent in inflation every year, you may not be getting ahead financially. For example, if the bond is giving you 5 percent per year and there is 3 percent inflation, you only made 2 percent for the year.


Another type of risk that you are going to have to be aware of is the risk of default. As a bond holder, you are in a better position than an individual that owns stock in a company. If a company goes into default, the stock holder is going to lose their entire investment. If you are a bond holder, you are considered to be a creditor and you will have a chance to collect some of the assets when the company goes out of business. However, if the company has so much debt that they do not have enough assets to cover it all, you may not get anything back. 


Reinvestment risk is another type of risk that is associated with fixed income investing. This type of risk deals with the possibility that you are going to have to reinvest the interest payments that you receive at a lower interest rate. For example, let's say that you have a bond that pays you 6 percent per year. This year, the market interest rate is only at 3 percent. When you receive your interest payments from the bond, you are only going to be able to reinvest them back into the market at 3 percent. 

blog comments powered by Disqus