Consider the level of risk you are prepared to take before you invest.
Risk essentially means the possibility of losing some or all of the money you have invested. Risk levels differ for each asset class.
There is also a risk in doing nothing and leaving your money in a low-interest savings account or an investment that pays little interest.
What is Your Risk Profile?
Your risk profile is a measure not only of your willingness to accept risk but also your ability to lose money. Both you and your advisor need to consider both when assessing how suitable an investment is for you.
Every investment carries some type of risk, and there’s no right answer to the question of how much risk you should take. The general rule of thumb is that the older you are, and the smaller your savings, the less risk you can handle. Never feel obligated or pressured to take on investment risk that makes you feel uncomfortable.
Types of Investment Risk
There are two types of risk: market risk and company-specific risk.
Market risk relates to factors that affect the economy or markets where stocks, bonds, and other securities are traded. Market risk affects all companies’ stock regardless of financial condition, management, or capital structure. The most common types of market risk are:
- Interest Rate Risk – The interest rate reflected in an investment’s value changes, thus changing the value of the investment.
- Inflation Risk – Prices of goods and services increase, therefore reducing the purchasing power of the money you earn on the investment over time. Inflation risk and interest rate risk are closely tied because interest rates usually increase with inflation.
- Currency Risk – The value of one currency changes against the value of another. If you need to convert from one currency to another to make an investment, any change in the conversion rate between those currencies can increase or reduce investment returns.
- Liquidity Risk – You are unable to buy or sell investments quickly for a price that is close to the underlying value of the asset.
- Socio-Political Risk – Social unrest or political decisions will affect investment markets. Some examples: terrorist attacks, war, changes in tax policy or expropriation of assets, etc.
- Systemic Risk – An entire market (or system) will crash.
Company-specific risk relates to the operations, management, or financial condition of a company, which can change. Common company-specific risks include:
- Management Risk – Inexperienced or unethical management team members, or simply, bad management decisions can affect a company’s performance.
- Credit Risk – A borrower, such as a bond issuer, doesn’t pay interest as scheduled or repay the principal at maturity.
See our Diversification page for an explanation of how to manage risk in an investment portfolio.