Simple definition
Interest-rate risk is the danger that rising interest rates will push down the value of bonds you already own. Bond prices and interest rates move in opposite directions: when new bonds pay more, your older, lower-paying bond is worth less. Think of it as a seesaw — rates up on one side, bond prices down on the other.
Why it matters
Interest-rate risk is the core reason a supposedly safe bond can still lose value. When rates rise, the price of existing bonds falls, and longer-term bonds fall the most. If you hold to maturity you're repaid in full, but if you must sell early, you could take a loss you didn't expect.
Real-life example
Suppose you own a bond paying 3% and new bonds start paying 5%. No one will pay full price for your lower-paying bond, so its market value drops. If you hold it to maturity, you still get your money back. These are rounded, hypothetical figures to show the inverse relationship, not real rates.
Common mistakes
- Believing a bond can't lose value because it's considered safe from default.
- Ignoring that longer-term bonds fall more in price when rates rise.
- Planning to sell a bond early without accounting for where rates may be then.
- Confusing default risk with interest-rate risk — a bond can be safe from one but not the other.
Pro tips
- Favor shorter maturities or duration for money you may need before the bond matures.
- Hold quality bonds to maturity to sidestep selling at a rate-driven loss.
- Use a bond ladder so not all your bonds are exposed to one rate move.
- Check a bond fund's duration to gauge how much rising rates could hurt its price.
Related Money Dictionary terms
- BondA loan you make to a government or company that pays you interest and returns your money on a set date.
- Reinvestment RiskThe chance that when a bond or CD matures, you can only reinvest the proceeds at a lower interest rate.
- Bond LadderA set of bonds with staggered maturity dates so a portion comes due at regular intervals for steady access to cash.
- YieldThe income an investment pays you each year, shown as a percentage of its current price.
- Treasury BondA long-term loan to the U.S. government that pays fixed interest and is considered very low risk.
- DurationA measure of how sensitive a bond's price is to changes in interest rates, shown in years.
Frequently asked questions
Why do bond prices fall when interest rates rise?
Because new bonds start paying the higher rate, making your older, lower-paying bond less attractive. To sell it, you'd have to drop the price until its return matches what buyers could get on new bonds. This inverse relationship — rates up, prices down — is one of the most dependable facts about bonds.
Does interest-rate risk matter if I hold a bond to maturity?
Less so, for that bond. If you hold a quality bond until it matures, you're repaid the full face value regardless of how rates moved in between. Interest-rate risk mainly bites when you sell early, because the market price could be lower than you paid. Holding to maturity is one way to manage it.
Which bonds have the most interest-rate risk?
Generally, bonds with longer maturities and lower coupons are the most sensitive, a sensitivity captured by a measure called duration. The longer your money is tied up, the more a rate change swings the bond's price. Shorter-term bonds move less, which is why they're often used for money you'll need sooner.
Knowing what Interest Rate Risk means is knowledge — the first half. A brick gets placed when you act on it: check the average duration of a bond fund you own to see how sensitive it is to rising rates.
Also builds: Retirement & Financial Independence
Sources & references
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Plain-English education — not personalized legal, tax, or investment advice.