Risks of Fixed Income Investments (Bonds)

by ABC

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If you are not familiar with fixed income investments then click here for an introduction to fixed income investments.

Fixed income investments are defined as securities that have a regular fixed return or payment associated with them such as bonds.

Here are some risks to consider when investing in fixed income investments.

Inflation – Because the payments on your investment are fixed, while they might be a fair rate at the time you purchased the investment, if interest rates go higher because of higher inflation then you will be essentially losing some money because you are only getting paid at a rate of 5% but someone who is buying a similar bond today would be getting a better rate.

Price fluctuations – Bonds are priced according to their coupon (or interest rate) and the length of time remaining until they come due.  If interest rates increase then the value of your bond will decrease if you try to sell it before it comes due.  Conversely, if interest rates decrease then the value of your fixed income investment should increase.

Government risk – For government bonds, you have to consider the possibility that the government won’t pay the interest or the principal.  In the case of US government bonds, that possibility is extremely remote.  However, what if you own bonds issued by a municipality?  or a foreign government such as Mexico?

Company risk – Bonds issued by companies are only as good as the companies behind them.  If you buy company bonds (or invest in bond mutual funds that do) then it is important to be diversified because one fact that separates company issued bonds from government issued bonds is that governments have the ability to increase taxes and raise more money which companies cannot do.

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