One important factor of investing in an Online Trading Platform is knowing the types of investment risk, and how they affect your investment returns. This can help you to avoid the biggest risk of permanently losing your capital.
Risk is a deviation of an expected outcome, as pointed out by like HQBroker Review.
In investing, we can look at risk as a deviation of expected investment returns that could be either positive or negative.
Learning the types of investment risk provides an investor to manage risk and making the most of outcomes.
Let’s discuss the 10 types of investment risk.
Interest Rate Risk
Interest rates have an effect on countries’ exchange rates. If a certain country’s interest rates rise, its currency will strengthen because of an influx of investments in that country’s assets. That is because a stronger currency provides higher returns. On the other hand, if interest rates fall, its currency will decline as investors begin to withdraw their investments. Thanks to the effects of interest rates, the differential between currency values can result to dramatically change forex prices.
Liquidity Risk
Liquidity is a measure of how easy or difficult to sell an asset. This type of risk is the possibility that an investor unable to buy or sell an investment because opportunities are limited. Currency is very liquid, but real estate is illiquid. Money tied up for a year in a fixed rate bond is also illiquid, but that’s a given when you invest. You are accepting interest rate risk, and the risk that you need your money before the term is up.
Inflationary Risk
Inflationary risk is the possibility of the value of an asset or income to be eroded if inflation shrinks the value of a country’s currency. In addition, it’s the risk that future inflation will make the purchasing power of cash flow from an investment to weaken. This can be countered with appreciable investments, such as stocks or convertible bonds.
Business Risk
This risk is associated with a particular security. It also refers to the risk associated with a specific issuer of a security. This is the possibility that the issuer of a stock or a bond may go bankrupt or unable to pay the interest or principal in the case of bonds.
Currency Risk
Currency risk involves owning foreign investments. It’s the risk of losing money due to a movement in the exchange rate. If, for example, the US dollar becomes less valuable relative to the British pound, your US stocks will be worth less in British pounds.
Concentration Risk
This risk refers to your money being concentrated in one investment. To fight off this risk, you need to diversify your investments. Doing this can spread the risk over different types of investments, significantly reducing your overall risk.
Credit Risk
This is the risk that the government entity or company issued the will run into financial difficulties, and won’t be able to pay the interest or repay the principal at maturity.
Reinvestment Risk
This is the risk of loss from reinvesting principal or income at a lower interest rate. Let’s say that many years ago you bought a Treasury Bond paying 9% that is maturing. Now the interest rate is less than 2%. If you reinvest, it would have to be at a much lower rate.
Horizon Risk
This type of risk refers to your investment horizon that can be shortened because of an unforeseen event. One good example is losing your job. This may force you to sell investments that you were expecting to hold longer. If you need to sell at a time when the markets are down, you may lose a huge amount of cash.
Political Risk
This risk associates the possibility of nationalization, unfavorable government action, or social changes resulting in a loss of value. An example is the US Congress that has the power to change laws. These could affect securities, and any ruling that results in adverse consequences. This is also known as legislative risk.
Bottom Line
One good strategy to reduce these types of investment risk is diversification. It is your best friend when trying to lessen investing risks. In addition, once you understand the different types of investment risk, you can mitigate and minimize your risk with reliable portfolio management tools.
