1. Although fixed income products provide stability to one's asset portfolio, awareness of risk elements in them is of paramount importance too.
2. Interest rate risk is relevant for investors who trade fixed income securities in the secondary market, which can be minimized by investing in shorter maturity securities, or those with different duration.
3. Liquidity risk is where the investment can’t be bought or sold quickly, which can be minimized by investing in highly rated instruments as their marketability is higher, or in Government securities, while corporate deposits are not as liquid.
4. Reinvestment risk is where the reinvested money won’t earn the same return as the original investment, which can be minimized by staggering potential call dates of different bonds, reducing the chances of all being called at once.
5. Inflation risk reduces the value of returns due to inflation, as purchasing power of your fixed income return declines, which can be minimized by dividing the investments evenly among bonds that mature at regular intervals, also known as bond laddering.
6. Downgrade risk exists where your investment’s credit rating may be downgraded by various credit rating agencies, which can be minimized by refraining from buying securities with negative outlook.
7. Default risk is where the promised returns or the principal are not received - XXX-rated bonds have a high default risk while AAA-rated corporate instruments are lesser risky - which can be minimized by buying securities with higher credit ratings.
8. Fixed Deposits are prone to risks of interest rate, liquidity, inflation and reinvestment.
9. Corporate Deposits are prone to risks of downgrade and default.
10. Once we acknowledge that all financial instruments are risky, we can just focus on avoiding risky mistakes in them as per our risk profile, instead of seeking unrealistic capital protection at all times, and put our hard-earned money to work harder for us.
2. Interest rate risk is relevant for investors who trade fixed income securities in the secondary market, which can be minimized by investing in shorter maturity securities, or those with different duration.
3. Liquidity risk is where the investment can’t be bought or sold quickly, which can be minimized by investing in highly rated instruments as their marketability is higher, or in Government securities, while corporate deposits are not as liquid.
4. Reinvestment risk is where the reinvested money won’t earn the same return as the original investment, which can be minimized by staggering potential call dates of different bonds, reducing the chances of all being called at once.
5. Inflation risk reduces the value of returns due to inflation, as purchasing power of your fixed income return declines, which can be minimized by dividing the investments evenly among bonds that mature at regular intervals, also known as bond laddering.
6. Downgrade risk exists where your investment’s credit rating may be downgraded by various credit rating agencies, which can be minimized by refraining from buying securities with negative outlook.
7. Default risk is where the promised returns or the principal are not received - XXX-rated bonds have a high default risk while AAA-rated corporate instruments are lesser risky - which can be minimized by buying securities with higher credit ratings.
8. Fixed Deposits are prone to risks of interest rate, liquidity, inflation and reinvestment.
9. Corporate Deposits are prone to risks of downgrade and default.
10. Once we acknowledge that all financial instruments are risky, we can just focus on avoiding risky mistakes in them as per our risk profile, instead of seeking unrealistic capital protection at all times, and put our hard-earned money to work harder for us.