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.
- Reinvestment Risk
The possibility that interest rates may have fallen by the time your investment reaches maturity. If this occurs, you may be unable to reinvest your funds at the rate of return you were accustomed to receiving. When interest rates drop, bond prices generally rise because the market is willing to pay more for a higher coupon. When interest rates rise, bond prices generally fall because the market will pay less for a lower coupon.
- 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.
- Market Risk
Yields and market value of bonds will fluctuate so that your investment, if sold prior to maturity, may be worth more or less than its original cost.