Top Risks of Fixed Income Investing
Investing when you have a fixed income is rather challenging. It is essential to analyze all possible risks before you invest. This way you will not lose much needed income in the process. You should also evaluate the companies with whom you will invest. This way you will avoid scams.
Top Risks of Fixed Income Investing
Interest Rate Risk: If an interest rate rises, bond prices decline. If an interest rate declines, bond prices will increase. This risk exists because new bonds are issued with higher yields as interest rates increase, making the old bond less attractive. The longer a bond fund's maturity, the greater the impact of change in interest rates can have on its price. If you do not hold your bond until maturity you may experience a gain or loss when you sell your bond.
Credit Risk: Credit risks is a greater concern for high yield bonds and bond funds that invest in lower-quality bonds and bond funds may invest in both investment grade-quality and high-yield bonds. It is important to read a fund's prospectus before investing to make sure that you understand the funds credit quality guidelines.
Inflation Risk: High inflation rates can erode the real value of the income you receive, inflation can jeopardize any fixed income stream on which you may be counting. You may want to consider a bond or bond fund that has its principal adjusted for increases in the inflation rate.
Call Risk: A callable bond has a provision that allows you to call, or repay the bond early. If interest rates drop low enough, the bond's issuer can save money by repaying its callable bonds and issuing new bonds at lower coupon rates. If this happens, the bond holder's interest payments cease and they receive their principal early. Then if the bond holder reinvests the principal in bonds, you will have to accept a lower coupon rate. This will lower monthly interest payments.
Prepayment Risk: Prepayment risk is the risk that the issuer of a security will repay principal prior to the bonds maturity date, therefore changing the expected payment schedule of the bonds. This is especially prevalent in the mortgage-backed bond market, where a drop in mortgage rates can initiate a refinancing wave.
Reinvestment Risk: In periods of declining interest rates, you may be forced to buy bonds at lower, prevailing interest rates as your existing investments reach maturity.