Making investments is the first step towards financial freedom, and then slowly build on the knowledge, ability, and risk appetite to make your assets work for you. However, all investments carry certain investing Risks. And, every investor putting together and managing a portfolio must understand that investing risks can hurt your stock portfolio, viz. the types of risk to investment, your investing risk tolerance, etc.
What are Investing Risks?
Investing Risks are risks that threaten to erode or reduce the value of your investment portfolio. Investing, by definition, is meant to grow your portfolio, but every investment carries certain inherent risks called investing risks. These risks can make your investments vulnerable and lose value instead of building value and wealth. Understanding investing risk enables you to mitigate it enough to match your risk tolerance.
What are the types of investment risks that could hurt your portfolio?
When investing, every strategy entails different levels of risk. As an investor, you must know the types of risk to investments to gauge them and create the best mix of assets for your portfolio.
The types of investing risks are:
Market Risk is the predominant risk when dealing with open market forces. Various fluctuations affect the prices of securities in the market and this “systematic risk” is due to the volatile nature of the market. Equity Risk, Interest rate risk, liquidity risk, and currency risks are types of market risks to your investment.
- Equity Risk: Equity investments are a fruitful but risky investment category, and you must dip your toes into it with proper guidance and knowledge. If the share price of the Company invested in drops – your portfolio could take an immediate hit.
- Interest Rate Risk is simply the risk of a fall in the rate of assets that gives you a fixed percentage of interest as returns.
- Liquidity Risk: Liquidity Risk is a risk of loss when you cannot meet payment obligations when they are due or find the cost of meeting payments too expensive. You may face such a risk even when you invest in securities.
- Currency Risk: If you have foreign investments, you may also have to deal with Currency Risk, which is a risk arising from foreign currency rate exchange fluctuations.
Non Diversification or Concentration Risk
One of the most significant investing risks is not diversifying your investments. Diversification can mean investing in sectors like infrastructure, technology, pharmaceuticals, etc. However, you can diversify to mitigate risk by investing in different securities. For example, if one industry is in a downturn and you lose money, the other sector may do well and keep your portfolio in the green.
Often, industry-specific occurrences may make specific sectors dip, but another industry could be going through an upswing. Rarely do all sectors perform poorly at the same time. A financial advisor helps you manage such risks by investing in a diversified portfolio of investments based on your risk tolerance.
Bonds are considered safer investments with less investing risks – and are the preferred choice for people with low investing risk tolerance. However, you must check bonds’ credit ratings before investing in them. If the companies issuing the bonds are not financially sound, you may face an investing risk called Credit Risk when the Company that issued the bonds faces difficulties.
Floating Rates or Reinvestment Risk
Often securities have a reinvestment clause to give you the benefit of compounding interest and make your money grow. However, inflation or other causes may reduce the interest rate when your money is reinvested.
Time or Horizon Risk
Every investment has a horizon period over which you can mitigate risk making the asset profitable. Generally, the longer the period, the lesser the investing risk associated with it. But sometimes unforeseen events may cause you to sell your assets sooner than expected, and that reduction in period may affect your investing profits.
Investing Risks are inevitable – but do you know your Risk Tolerance:
Investing Risks exist, and that is a fact. But with clever and informed investing – you can still make your money work for you and earn well. Once you know the amount of investment risk you are willing to take on, that becomes your investing risk tolerance threshold. The factors that affect your tolerance are your temperament, how much time and financial ability you have, the age and stage of life you are in, etc. So, invest carefully based on your investing risk tolerance levels.
Investing risk affects everyone – here is how you can mitigate it to your risk tolerance levels. There are knowledge tools you can apply to minimize your investment risk. Take timely updates and advice from reputed and informed sites and agencies. Make diversified investments, and invest based on your risk appetite.
However, if you go about it, the idea is to invest your money to earn high returns. Not investing because there are risks involved means your investments will not grow. So, if you want to create wealth, start investing today!