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There are many types of risk
in investing. Generally, when you hear someone talking about "investment risk"
they're referring to market risk (or short-term risk), which is the fluctuation in an
investment's return. Investments with wide swings in return (potential for very high gains
but also for very high losses) are said to be high-risk, while those with more stable
returns are said to be low-risk.
Additionally, there are other types of investment risk you should be aware of:
Inflation, or long-term, risk. This is the risk that the rate of return on your investment
over time will not be high enough to offset the effect of inflation, which eats away at
the buying power of your savings. Inflation risk could result from investing too
conservatively, while market risk increases with more aggressive investments. Generally,
investments that have a low degree of market risk also have a high degree of inflation
risk, and vice versa.
Interest rate risk. This is the risk that interest rates will go up after you've locked
your money into a fixed-rate investment.
Liquidity risk. The risk that you won't be able to sell your investments quickly for the
price you want.
Business risk. The risk that the company or industry you've invested in won’t do
well.
Credit risk. The risk that a borrower won't be able to repay his debt.
If you're investing internationally, there are additional risks to consider, such as:
Exchange rate risk. The risk that when you change your money back from foreign currency to
U.S. currency, the exchange rate may have changed to your disadvantage.
Capital restrictions. Since each country has its own rules on capital flows across
international borders, the availability of investments in some countries might be
restricted.
Political risk. The risk that a political event in the country you’re invested in
will negatively affect your investment.
Different regulatory structures. Investors in the U.S. are relatively well protected by a
vast structure of regulations governing financial transactions, financial reporting,
accounting, disclosures, etc. In other countries, the rules are likely to be different.
The unknown. Securities in the U.S. are well-tracked by many analysts. For an investment
outside the U.S., information might be difficult to come by.
The most important thing to remember is that there's no such thing as a risk-free
investment. Your goals as an investor are A) not to take more risk than you are
comfortable with and B) to make sure the returns your investments earn are worth the risks
you take. |
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