While there is no way to get around taking on risk, knowing the different types of investment risk can help you and your advisor put together a portfolio that minimizes over exposure to any one risk factor. Below are some of the most common and impactful risks to your investments.
Inflation risk is essentially the risk that your investments growth will not keep up with the rate of inflation and therefore reduce your purchasing power and return on investments. Fixed income vehicles, such as bonds, are especially prone to inflation risk.
Business risk is the possibility that a company’s profits could be lower then expected. This could be due to a number of factors such as employee strikes, new products, competing firms, bad public relations, among other things. Almost all investment products are subject to this risk.
A security that is difficult to sell is said to be illiquid, and therefore is experiencing liquidity risk. If an asset cannot be quickly converted to cash at a fair price, it may cause the investor to miss buying or selling opportunities.
Interest Rate Risk
Investors are exposed to interest rate risk when there is a changing interest rate. For example, fixed income securities (bonds) have an inverse relationship to interest rates. Therefore, if the interests rise then bond prices will fall, and vise versa.
Currency risk, or foreign exchange risk, is the risk that an investor will incur losses resulting in unfavorable change in exchange rates. Currency risk presents itself to anyone who has foreign investments.
Default risk occurs when a company issues more debt than it can financially maintain. When this happens, the company is at risk for defaulting on their debt and therefore not making interest payments or repaying a loan principal due.
There are however, risks that cannot be eliminated from a portfolio. These are known as systematic risks. Systematic risks are always present, cannot be eliminated, and exist in all asset classes. Also known as market risk, systemic risk cannot be diversified away and effects the market as a whole.
“The COVID-19 (Coronavirus) worldwide outbreak is an example of systematic risk. This outbreak impact on the markets in a similar way to a global resection.”
Risk is unavoidable and is unfortunately something that investors need to plan for. Investors should work with their advisors to ensure that their portfolios are diversified in a way that aligns to their personal risk tolerance.
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