What is Reinvestment Risk?

Full Definition

Reinvestment risk is the risk that, when an investment matures or pays out income, the proceeds can only be reinvested at a lower rate of return than the original investment was earning -- typically because market interest rates have fallen in the meantime. It affects fixed-income investments such as bonds, fixed-rate savings bonds and gilts particularly directly: an investor holding a bond paying regular coupons faces reinvestment risk on each coupon payment (which must be reinvested at whatever rate is available at the time), and faces it again in full when the bond matures and the principal is returned, needing to be placed into a new investment at the interest rates then prevailing. Reinvestment risk works in the opposite direction to interest rate risk (the risk that a bond's market price falls when rates rise) -- a falling-rate environment is bad for reinvestment risk but good for the market value of existing fixed-rate bonds, while a rising-rate environment is the reverse, which is why the two risks are often considered together when building a fixed-income portfolio. Strategies used to manage reinvestment risk include "laddering" -- holding bonds or fixed-rate savings products with a spread of different maturity dates rather than all maturing at once -- so that only a portion of the portfolio needs reinvesting at any given point, reducing the impact of reinvesting everything into a single unfavourable rate environment.

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