There are different kinds of investment risk that you can be exposed to after deciding to enter the market.
Let us discuss some of those potential risks and how it can affect you investment returns.
1. Concentration Risk
This is when you put your investments in a small number of securities, sectors, or industries. Remember that when you diversify, you also spread out the risk over different types of investments and geographic locations.
2. Liquidity Risk
This refers to when you, as an investor, end up in a situation wherein you might not be able to buy or sell your investment when you want or in enough quantities due to opportunities being limited. When you decide to sell, you may need to settle for a lower price. There are also some cases where you won’t be able to sell your investment at all.
3. Currency Risk
This pertains to when you invest in currencies, currency derivatives, or similar instruments. It also includes securities that use foreign currencies. The risk here lies in the possibility of losing money due to movement in the exchange rate.
4. Equity Market Risk
This applies to investment in shares. Equity markets are subject to several factors. These factors include economic conditions, government regulations, market sentiment, local and international political events, and environmental and technological issues. This is the possible loss due to a drop in market price of shares.
5. Credit risk
This involves debt investment like bonds. This relates to government entity or company that issued the bond. The problem lies on the issuer running into financial difficulties. They will therefore no longer be able to pay the interest or repay the principal at maturity.
6. Commodities Risk
Being exposed to commodities market can be more volatile compared to the traditional equity or fixed income securities. Changes in overall market movements, commodity index volatility, interest-rate changes, or events affecting a particular commodity or industry can change the value of a commodity.
7. Foreign Investment Risk
Investments in foreign markets may present risks that are not usually found on domestic markets. These may be comprised of changes in currency exchange rates; less-liquid markets and less available information; less government supervision of exchanges, brokers, and issuers; increased social, economic, and political uncertainty; and greater price volatility.
8. Interest Rate Risk
This applies to debt investments such as bonds. You can lose money due to a change in interest rate. The changes in interest rates can badly affect investments.
9. Reinvestment Risk
This comes as the possible loss through reinvesting principal or income at a lower interest rate. This will not apply if you decide to spend the regular interest payments or principal at maturity.
This will mostly affect your purchasing power if the value of your investments doesn’t keep up with inflation. Inflation has the power to wear down the purchasing power of money over time. This could mean that the same amount of money can let you buy fewer goods and services. This is mostly relevant if you own cash or debt investments like bonds. Shares are mostly covered due to the companies being able to raise the prices in line with inflation. Real estate also offers some protection because landlords can increase rent over time.
Read more about how to lower your investment risk.
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