Investment Risk - There is no such thing as a no risk investment

Investment risk is a natural component of the financial market. Nevertheless, the appropriate level of risk varies depending on your personal situation, objectives, and risk tolerance. People have different comfort levels with risk, with some being more at ease with it than others. While some are prepared to accept higher levels of risk to meet their goals, others have differing thresholds for different types of risk.

UNDERSTANDING INVESTMENT RISK

Prior to making an investment, it is essential to understand the risks involved and determine your comfort level with risk. The potential returns from various types of investments, as well as the associated risks, fluctuate over time due to economic, political, regulatory changes, and other factors.

RISK TOLERANCE

Examining risk tolerance can be approached from various perspectives. One method involves assessing your reaction to potential short-term losses in investments. Feeling anxious at the idea of a decrease in your account balance suggests a more risk-averse approach. Conversely, being at ease with short-term losses in anticipation of long-term benefits indicates a higher willingness to embrace risk.

VOLATILE INVESTMENTS

Another aspect to take into account is your tolerance for volatility. Volatility indicates the extent of price fluctuations over a period of time. Investments with higher volatility will experience more significant fluctuations in value, whereas investments with lower volatility will undergo more gradual and consistent price variations.

STABILITY AND SLOWER GROWTH

Certain investors are drawn to the possibility of substantial profits from investments with higher volatility, while others favor investments providing stability and gradual growth. Therefore, assessing your risk tolerance is crucial in making informed investment choices and steering clear of either excessive or insufficient risk levels based on your objectives.

DIFFERENT TYPES OF INVESTMENT RISKS

There’s no such thing as a ‘no-risk’ investment. You’re always taking on some risk when you invest.

Here are some of the common types of investment risks:

CAPITAL RISK

There is a risk that your investments may lose value, resulting in a potential loss of your initial investment. Stock market investments usually involve purchasing shares (equities), either directly or through a fund. The value of stocks in the market can vary significantly on a daily basis.

Depending on the specific company or companies you have invested in, you may experience partial or total loss of your investment. Other assets such as property and bonds can also decrease in value.

INFLATION RISK

The purchasing power of your savings declines. Even if your investment increases in value, you may not be making money in 'real' terms if the things you want to buy with the money have increased in price faster than your investment. Cash deposits with low returns may expose you to inflation risk.

CREDIT RISK

Credit risk is the risk of not achieving a financial reward due to a borrower’s failure to repay a loan or meet a contractual obligation. Credit risk is closely tied to the potential return of an investment, the most notable being that the yields on bonds correlate strongly to their perceived credit risk.

LIQUIDITY RISK

You are unable to access your money when you want to. Liquidity can be a real risk if you hold assets such as property directly and in the 'bond' market, where the pool of people who want to buy and sell bonds can 'dry up'.

CURRENCY RISK

Currency risk is the potential risk of loss from fluctuating foreign exchange rates when investments are exposed to foreign currency or in foreign-currency traded investments.

INTEREST RATE RISK

Changes to interest rates affect your returns on savings and investments. Even with a fixed rate, the interest rates in the market may fall below or rise above the fixed rate, affecting your returns relative to rates available elsewhere. Interest rate risk is a particular risk for bondholders.

MAKING INFORMED INVESTMENT DECISIONS

Although avoiding risk completely is not possible, you can mitigate it by spreading investments across different assets over an extended period and consistently adding funds to your investments instead of making one lump sum. This strategy can aid in balancing out fluctuations and minimizing the chances of substantial losses.

Having a clear understanding of your risk tolerance is crucial for making well-informed investment choices and reaching financial objectives.