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What are the risks of investing?

What are the risks of investing?

Posted on: December 14, 2011
Author: Staff

There are many dangers around us and many things we’re afraid of, but they’re not always the same thing. If we’re not aware of a danger, it doesn’t make it any less dangerous—although it does make us less afraid. In some cases, our ignorance unknowingly puts us in greater danger. Conversely, there are other things we may fear but, in reality, pose little threat to us. A greater level of understanding will help us in both scenarios.

Because of the risks involved in investing, we need to understand what the real dangers are and minimize our unwarranted fears. Understanding the factors that affect our investments will make us more knowledgeable and help us to make better investment decisions.

Here are the five main investment risks:

Inflation Risk

When you were younger, things cost less. That’s inflation. The amount you can purchase with a dollar goes down every year by the inflation rate. Where we could once buy a candy bar for 25 cents, we now have to pay a dollar for the same thing. Inflation has reduced the purchasing power of a dollar over time. This can have significant impact on your investments. If your investments do not perform above the inflation rate over time, they will actually be worth less in the future in terms of their purchasing power.

Company Risk

If you hold shares of a company, they may decline based on poor performance or bad news coverage. In a worst-case scenario, a company can go out of business rendering the shares worthless.

Interest Rate Risk

Some investments are sensitive to interest rates. This is especially true for fixed income investments. Generally, when interest rates fall, fixed income investments increase in value. But conversely, when interest rates increase, fixed income investments decrease in value.

Credit Risk

Companies and governments may suffer adverse changes in their financial condition, and this may lower the credit rating on the bonds they have issued. This will lower the value of their bonds.

Liquidity Risk

Liquidity risk refers to being able to sell an investment in a timely manner for fair value. Imagine finding out that you had to sell your home in 24 hours. Do you think that you would get fair market value or would have to settle for something less? That’s liquidity risk.

These are just some of the main types of risks involved in investing. Understanding them will help you become a better investor.

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