Modern solutions in materials engineering are designed not just for the improvement in the mechanical or electromagnetic properties of materials but also to begin to fulfill specific functional roles. A good example of such a modern solution is a composite made of steel and rubber–ferritic conglomerate, which is the research object of the article. The composite, when properly magnetized, can act as a magnetic encoder ring for reading the angular displacement, speed, or acceleration parameter. The paper addresses the problem of identifying and assessing the defects of the magnetic encoder ring domain structure in the form of a radially magnetized ring. It discusses the essential types of the ring’s degradation, such as mechanical, thermal, and magnetic, and presents problems related to the identification of emerging defects. The conducted research allows a better understanding of the degradation process in the context of magnetic encoder ring reliability. Based on the conducted research on the proposed test stand, it is possible to track the progressive degradation related to each effect. These degradation case analyses consider both quantitative and qualitative changes in the encoder ring’s domain structure. The proposed parameters show the possibilities and perspectives for detecting the ring’s defects in the early stage of its development. Solely such an approach will allow for proper exploitation and extension of the applicability of this kind of ‘intelligent material’. Additionally, the developed parameters for the encoder ring’s defects detection can support the progress of rapidly evolving methods for diagnosing mechanical systems based on a signal from such an element.