A complicating factor with investment risk is that
in protecting yourself against one type of risk, you often are
vulnerable to another.
For example, in reducing your exposure to the market risk posed
by stocks, one place to turn is fixed-income investments, especially
those with the highest safety ratings, which generally hold out
the smallest risk of losing money. But high-rated bonds are typically
issued at lower interest rates than more speculative bonds, which
limits their total return.
If those bonds are issued in a period when interest rates in general
are low, you are also taking on substantial
interest-rate risk
. That's the risk that interest rates will go
up at some point in the future, with three probable results:
Newly issued bonds
will pay a higher rate than the bonds you buy today
The bonds you buy
today will be worth less than par in the secondary market
Stocks will be depressed
as investors put more money into bonds to earn the higher
rate at what they perceive to be less risk
Inaction isn't the answer
The response to interest-rate risk isn't avoiding fixed-income
investments. Rather, it's diversifying your holdings to include
bonds with varying terms, using barbell or laddering strategies that limit your exposure to a single bond,
or bonds with the same term, without sacrificing the stability
that these investments can provide in your portfolio.
Thomas J. Dorsey, President and
co-founder of Dorsey, Wright &
Associates
Thomas J. Dorsey, President and
co-founder of Dorsey, Wright &
Associates 
