What is referred to as reinvestment risk?

Reinvestment risk specifically pertains to the uncertainty that arises when an investor receives cash flows from an investment but faces the possibility of reinvesting those cash flows at lower yields than the original investment. This situation often occurs with fixed-income securities, such as bonds, that pay periodic interest. When interest rates fall, new bonds may be issued at lower yields, making it challenging for investors to reinvest their coupon payments or the principal upon maturity at a similar rate of return.

In settings where cash flows are recycled back into new investments, the effective return can decrease if market conditions change unfavorably. This makes reinvestment risk a significant consideration for investors who depend on consistent returns over time, particularly in a declining interest rate environment. Understanding and managing this risk is essential for maintaining expected investment performance.

This concept does not relate to the potential loss of principal due to market fluctuations, the inability to liquidate an asset, or the general volatility of stock valuations—it is specifically concerned with the rates available for reinvesting cash flows.