Interest rate risk is the possibility that changes in interest rates will negatively affect the value of your investments, particularly bonds and other fixed-income securities. When interest rates rise, bond prices typically fall, and vice versa.
For example, if you hold a bond paying 3% interest and new bonds are issued at 5%, your bond becomes less attractive, causing its market value to decrease. This inverse relationship between interest rates and bond prices is a fundamental concept in fixed-income investing.
Investors can manage interest rate risk by diversifying their bond holdings across different maturities, using bond laddering strategies, or investing in floating-rate securities that adjust their payments as interest rates change.