We encounter countless risks throughout our lifetime. Although risks can be intimidating, there are ways to manage and deal with them accordingly. Investment, like everything else, involves a certain degree of risk. You are exposed to different forms of risk when you invest. Even not investing at all has its own risk. An investor should be able to tolerate some amount of risk to build wealth.
The risk of investment refers to the potential for losses instead of projected return on investment. The expected profit is never guaranteed when it comes to investment. That’s why having an understanding of the risks involved in your investment is crucial for any investor, especially those who are less experienced.
Here are 6 types of investment risks that investors or potential investors should look out for:
Market risk happens when the stock market starts to fall. It represents the fluctuations of in-stock price. Market risk is the possibility of losing your investment capital due to factors such as currency, interest rate and equity which affect the market performance. Even if the assets of some industries remain unchanged, stock prices can still begin to decline.
Currency risk occurs when you are trading in the global stock market. This kind of risk refers to the feasibility of losing money due to currency exchange rate movements that would have an impact on the value of your investment. If your domestic currency depreciates against the foreign currency you have invested in, the value of your foreign investment will fall and the stock will become less valuable. No matter what country you invest in, you will need to convert it to your domestic currency if you want your return on investment back.
Interest rate risk is the possibility of losing money due to a change in interest rate. Interest rate risk applies to debt investments like bonds. Bond investment is very sensitive to the changes in interest rates. The market value of the bonds declines as interest rate rises. When the interest rate is low, borrowing money becomes cheaper and thus contributes to the raise of capital supply in the economy.
Credit risk is the probability of loss when the bond issuer such as the corporation or government is unable to pay the interest or principal at maturity. Credit risk applies to the investment of debts such as bonds. When the bond issuer fails to make the payment, the investor will lose money and the bond value also declines. It could also lead to the collapse of the bond issuer.
Investors may measure their credit risk by looking at the bond’s credit rating. Fitch and Standard & Poor’s use AAA for the best credit rate, followed by AA, A, and BBB for good credit indications. Anything below BBB is regarded as risky or worse, down to a default D rating.
You don’t need to be an investor to experience the impact of inflation. In investment, inflation risk is the likelihood of investors losing their buying power as the investment value couldn’t keep up with the inflation rate. Investors who own cash or debt investments such as bonds are significantly affected by the inflation risk. This is because the money will become less valuable. The cash flow of investments won’t be worth much due to the risk of purchasing power. But on the bright side, inflation risk does not apply to shares and stocks investments. Why? Because companies can increase their stock prices in order to beat inflation.
This is the risk of not being able to trade your asset for cash when you’re ready for a transaction. You may need to give up your capital or take a big loss by accepting a lower price due to lack of buyers or market inefficiency. Since there’s no potential buyer, you will have to keep holding the investment at the time when you’re in need of cash until you’re able to attract buyers. In certain cases, you may not be able to sell the asset at all. Liquidity risk refers to the difficulty of selling an investment or selling it below its fair price.
Whether you’re investing to generate high or low returns, it is important to consider these risks. As an investor, you should understand and evaluate your risk tolerance. Consider moving from low-risk investment to high-risk investment if you’re new to investing. High-risk investment doesn’t necessarily guarantee high returns. That’s why it’s advisable for you to do it step by step.
Understanding the investment risks involved is crucial. After all, no investment is risk-free. But what you can do is to figure out which investment is worth the risk.
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