Fixed-income
investments are typically considered to be less risky than stocks because they provide
a fixed rate of return over a specified period of time. However, there are
still risks associated with fixed-income investments that investors should be
aware of:
1. Interest rate risk:
Fixed-income securities are subject to interest rate risk, meaning that if
interest rates rise, the value of the security will decrease. This is because
newer securities with higher interest rates become more attractive to
investors, causing the price of existing securities to fall.
2. Credit risk:
Fixed-income securities are also subject to credit risk, meaning that the
issuer may not be able to make interest or principal payments as promised. This
risk is higher for securities issued by lower-rated entities, such as companies
with a lower credit rating or municipalities with weaker finances.
3. Inflation
risk: Fixed income securities are also subject to inflation risk, meaning that
the returns earned may not keep pace with inflation. This can erode the
purchasing power of the investment over time.
4. Liquidity risk:
Some fixed income securities may be less liquid than others, meaning that they
may be difficult to sell quickly without incurring significant losses. This
risk is particularly high for securities issued by smaller or less well-known
entities.
5. Call risk:
Some fixed income securities are callable, meaning that the issuer can call the
security back before the maturity date. This can be problematic for investors
who are relying on the steady income from the security, as they may have to
reinvest at a lower rate of return.
6. Prepayment risk:
This is particularly relevant for mortgage-backed securities. If interest rates
fall, homeowners may refinance their mortgages at a lower rate, resulting in
the early payment of the mortgage-backed security. This can leave investors
with cash that they must reinvest at a lower rate of return.
7. Currency risk:
Fixed-income securities that are denominated in a foreign currency are also
subject to currency risk, meaning that fluctuations in exchange rates can affect
the returns earned by the investor.
It
is important for investors to carefully consider these risks before investing
in fixed-income securities and to diversify their investments to
mitigate these risks.