What is Inflation Risk primarily associated with?

Inflation risk is primarily associated with the reduction of purchasing power for fixed income investors. This risk arises when the general price levels in an economy increase, leading to a decline in the value of money over time. Fixed income investments, such as bonds, typically provide a set return; however, if inflation rises, the real return (adjusted for inflation) on these investments diminishes. For instance, if an investor holds a bond that pays a fixed interest rate, and inflation increases, the amount of goods and services that the interest payments can buy effectively decreases, thus eroding the investor's purchasing power.

In contrast, other options address different types of financial risks. Increased interest rates can be a separate concern for different investments, while stock market crashes pertain to equity investments rather than fixed income. Illiquid assets relate to the ability to quickly convert an asset into cash, which is a different aspect of investment risk. Understanding inflation risk is crucial for investors to make informed decisions in maintaining their purchasing power over time.