| Fixed Income Investing: Risks |
There is no such thing as a risk-free investment. Here are some of the more common types of risk to consider when choosing fixed-income securities.
- Credit Risk: The risk that the issuer will default on its payments of interest and principal on its debt. You can help manage this risk by choosing only investment-grade bonds (rated BBB or higher) or by diversifying among several issues of high yield bonds. Or you can purchase bonds that are insured, a guarantee that interest and principal will be paid in the event of a default by the issuer. The insurance does not guarantee the original price if sold before maturity, or current market value.
- Market or Interest Rate Risk: The market value of bonds will fluctuate with changes in the level of interest rates. When interest rates drop, bond prices generally rise, because the market is willing to pay more for a higher coupon on outstanding bonds. When interest rates rise, bond prices generally fall because the market will pay less for a lower coupon on outstanding bonds. Therefore, your investment, if sold prior to maturity, may be worth more or less than its original cost.
- Reinvestment Risk: The possibility that you will reinvest coupon income from a bond at interest rates that are considerably lower than expected.
- Call Risk: The possibility that an issuer will retire a bond (pay back the principal) before its scheduled maturity date when interest rates decline, leaving you to reinvest your bond proceeds at lower interest rates.
- Inflation Risk: The possibility that the value of your investment may not grow enough to keep up with inflation, reducing your purchasing power as a result.
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