When it comes to investing, there are certain risks involved. This is often a source of concern for new investors especially, because unknown risk is not typically thought of as a good thing when it comes to your hard earned money. However, understanding the factors that affect your investments will minimize your fears by helping you make better investment choices.
The five main investment risks
1. Inflation Risk
Inflation is what brings the purchasing power of money down each year as the prices of goods and serves go up. It’s the reason why your favourite candy cost 2 dollars as a kid, and the same candy costs 4 dollars today. This can have a 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.
2. Company Risk or Market Risk
Purchasing shares, otherwise known as stocks or equity in a company, comes with some risk. Shares may decline based on the company’s poor performance or bad news coverage. In a worst-case scenario, a company can go out of business, rendering the shares worthless. You can be exposed to this risk if you purchase individual shares or stocks, mutual funds or Exchange Traded Funds (ETFs).
3. 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, interest rates increase, fixed income investments decrease in value.
4. Credit Risk
Both 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.
5. Liquidity Risk
Liquidity risk refers to being able to sell an investment in a timely manner for fair value. Imagine finding out that you have to sell your home within 24 hours. You would likely have to settle for something less than fair market value. That’s liquidity risk.