Potential Risks of Fixed Income Investments

While fixed-income products are mostly considered "safer" than some other asset classes, no investment is perfectly safe. Let's go through some of the potential risk factors that must be considered with fixed-income investing.

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Credit Risk or Default Risk

Corporate bonds may not have the guarantee of the government or FDIC, but do offer preferential treatment for debt holders over common stockholders if a firm cannot meet its debt obligations. US-based companies that issue debt have debt ratings, through which their required interest rates are determined, and investors can judge the credit risk for themselves. AAA rating is considered an investment-grade bond, while BB and below are considered high-yield (junk) bonds.

Interest Rate Risk

With fixed-income solutions, there is an interest rate risk that an investor will purchase a bond or bill, and the interest rates rise above its rate. This will cause the value of the instrument to lower in the secondary market, and the investor will be locked into that rate for the duration.

The risk is not that the investor will lose money, but will lose out on an opportunity to gain a higher rate - although a laddering strategy will still take advantage of the higher rates when the oldest bond matures.

Inflation Risk

Except for Treasury Inflation-Protected Securities (TIPS), fixed-income investments do carry inflation risk. There is a chance that inflation rises higher than the fixed rate during the investment's life. A proper laddering strategy, however, will maintain a balance of short, medium, and long-dated investments, which will provide opportunities to get newer, higher-rate securities at regular intervals.

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