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Investing RisksBy Roger Sorensen
Before you invest any of your money it is important you understand the trade-off between investment performance and risk. In a nutshell, the more risk you take the greater the performance if your investment works out and you make any money. The greater the risk, the bigger chance you will lose some or all of your investment.
Stocks historically have provided the highest long-term returns of the three major asset classes. This trend is tempered with the fact that stocks have also been subject to the biggest losses over shorter periods. At the other extreme, short-term cash investments are among the safest of investments while providing the lowest long-term returns.
There are various types of risk.
Personal Risks
This risk deals with the personal level of investing. The investor is likely to have more control over this type of risk compared to others.
Timing Risk: You buy the right security at the wrong time or selling the right security at the wrong time. There is no surefire way to time the market though many have tried.
Tenure Risk: This is the risk of losing money while holding onto a security as its value decreases.
Company Risks
Financial Risk: This is the danger that a corporation will not be able to repay its debts. This has a great affect on its bonds, which finance the company's assets. The more assets financed by debts (i.e., bonds and money market instruments), the larger the risk of default. Studying financial risk involves looking at a company's management, its leadership style, and its credit history.
Management Risk: This is the risk that a company's management team may run the company so poorly that it is unable to grow in value or pay dividends to its shareholders. This greatly affects the value of its stock and the attractiveness of all the securities it issues to investors.
Market Risks
Fluctuation in the market may be caused by any or all of the following risks:
Market Risk: This is the chance that the entire market will decline, thus affecting the prices and values of securities. Market risk is influenced by outside factors such as embargoes and interest rate changes.
Liquidity Risk: This is the risk that an investment will experience loss in value when converted to cash.
Interest Rate Risk: This is the risk interest rates will rise resulting in an investment's loss of value.
Inflation Risk: This is the danger that the dollars you invest will buy less in the future because prices of consumer goods rise. When the rate of inflation rises, investments have less purchasing power. Investments earning fixed rates of return are especially vulnerable to this loss.
Exchange Rate Risk: This is the chance that a nation's currency will lose value when exchanged for foreign currencies.
Reinvestment Risk: This is the danger that reinvested money will earn returns lower than those earned before reinvestment. Dividend-reinvestment plans are a group subject to this risk. Bondholders are another.
National And International Risks
National and world events can profoundly affect investment markets.
Economic Risk: This is the danger that the economy as a whole will perform poorly. Economic downturn stock prices, the job market, and the prices of consumer products.
Industry Risk: This is the chance that a specific industry will perform poorly. Problems in an industry affect the individual businesses involved as well as the securities issued by those businesses.
Tax Risk: This is the danger that rising taxes will make investing less attractive. Businesses that are taxed heavily have less money available for research, expansion, or dividend payments. Taxes can also be levied on capital gains, dividends and interest earned by the investor.
Political Risk: This is the danger that government legislation will have an adverse affect on investment. This can be high taxes, prohibitive licensing, or the appointment of individuals whose policies interfere with investment growth. Political risks include wars, changes in government leadership, and politically motivated embargoes.
Copyright Roger Sorensen
Next: Dollar Cost Averaging
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