What it is
As the name suggests, interest rate risk is the potential for investment losses caused by a change in interest rates. It is commonly seen in fixed-income instruments such as bonds, but can also indirectly other types of investments.
If interest rates increase, fixed-rate instruments that were issued earlier (which have a lower interest rate) become less attractive to investors. This makes their value drop. That’s why interest rates and bond prices have an inverse correlation; when one goes up, the other goes down and vice versa.
What it means for you
Money placed in fixed-income instruments or investment vehicles that have a lot of these in their portfolio (such as bond funds) will face interest rate risk. This is something that you must consider before investing in them.
Remember though that this risk does not affect the returns you can get from bonds, or the time it takes for them to mature.
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