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4 Risk Factors to Consider With Fixed Income Investing

  • Oppenheimer Asset Management
  • December 6, 2018
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Fixed income securities are by and large considered to be more secure than equities. That is because bonds are designed to generate a predictable return (hence the name “fixed income”) from the issuer ignoring external factors. That last part is important though because, as we know, external market conditions are never certain and always subject to fluctuate, leaving even the most predictably “stable” fixed income securities subject to certain risks.

While there are a number of risks associated with investing in fixed income securities, here are four of the more prominent risk factors:

1. Interest rates

Interest rates and bonds are said to have an inverse relationship: when interest rates rise, bond prices will fall and vice versa. This is because as interest rates rise, new bonds with higher coupon rates are issued on secondary markets, making previously issued bonds less attractive and more difficult to sell at their original price. This isn’t necessarily a concern if you are planning to hold onto a bond until maturity but if you are planning to sell prior to the maturity date, rising interest rates can infringe on your return. This is why understanding the duration of bonds you are holding is important.

2. Credit and default risks

Bonds carry different credit risks depending on the financial stability and likelihood of the issuer to pay the agreed income and principle amount on the investment. That risk is often assessed by rating agencies like S&P, Moody’s and Fitch which assign credit ratings that can impact the price of a bond. Lower ranked bonds typically carry a higher yield while higher rank bonds, like treasury bonds, offer a lower yield because they are typically more secure.

Regardless of credit rating, bonds are always subject to credit and default risks. Investing in bond funds made up of a basket of individual bonds can be a good way to hedge against the default or credit risk of an individual issuer.

3. Inflation

Monetary inflation can be a concern for fixed income investors, particularly if the rate of inflation exceeds the fixed value of the returned rate of a bond. Certain bonds, like U.S. Treasury Inflation-Protect bonds (TIPS) are designed to mitigate this risk by adjusting for inflation when the bond matures and the principle is returned.

4. Liquidity

There is no guarantee that there will be an active market for the buying or selling of a particular bond. Therefore liquidity can be an issue if you plan to sell a bond before maturity, at which case you may incur a loss on your investment. Liquidity risks are typically higher for lower rated bonds or bonds that were downgraded by a credit agency. Working with a broker-dealer with access to an active secondary market for various types of bonds is one way of lowering liquidity risk.

There is no guarantee that there will be an active market for the buying or selling of a particular bond. Therefore liquidity can be an issue if you plan to sell a bond before maturity, at which case you may incur a loss on your investment. Liquidity risks are typically higher for lower rated bonds or bonds that were downgraded by a credit agency. Working with a broker-dealer with access to an active secondary market for various types of bonds is one way of lowering liquidity risk.

 

These are just a few of the risks to consider when investing in fixed income securities. Ultimately, as with any asset class, having a strategy in place and an experienced Financial Advisor to help guide your financial decision-making is the best way to mitigate against potential losses.

Contact an Oppenheimer Financial Advisor to learn more about Fixed Income investment strategies.

Disclosures

©2018 Oppenheimer & Co. Inc. Transacts Business on All Principal Exchanges and Member SIPC. All Rights Reserved. 

The information contained here is general in nature, has been obtained from various sources believed to be reliable and is subject to changes in the Internal Revenue Code, as well as other areas of law. Neither Oppenheimer & Co. Inc. (“Oppenheimer”) nor any of its employees or affiliates provides legal or tax advice. Please contact your legal or tax advisor for specific advice regarding your circumstances.

No part of this brochure may be reproduced in any manner without the written permission of Oppenheimer & Co. Inc. 2358666.1

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