Laila Keith
Investing is a risky business. The main risk is losing money, but there's also the chance that you won't achieve your expected returns over a particular time period. Risk is broadly categorised as the chance that an investment's actual gain will differ from the expected outcome or return. There are several types of risk, including liquidity risk, concentration risk, and market risk. So why take the risk? Well, it could give your money the potential to increase in value above and beyond inflation.
| Characteristics | Values |
|---|---|
| Main risk | Losing money |
| Other risks | Not achieving expected returns, negative economic issues, losing entire value |
| Reward | Potential for money to increase in value above inflation |
| Risk management | Understanding basics of risk, learning risks that apply to different scenarios, and ways to manage them |
| Liquidity risk | How easy or hard it is to cash out of an investment |
| Concentration risk | The more investments you hold, the greater the risk |
| Inflation risk | Investments may not earn enough over time to keep pace with the increasing cost of living |
What You'll Learn
The possibility of losing money
The main risk of investing is the possibility of losing money. You might not get back what you put in and may not achieve your expected returns over a particular time period. The outcome of any investment is uncertain, due to the unpredictability of the market. For example, the performance of a company's shares could take a turn for the worse, or economic issues could have a negative effect on the stock market more broadly.
There are several types of risk that can lead to losing money. Liquidity risk refers to how easy or hard it is to cash out of an investment when you need to. Concentration risk refers to how many or how few investments you hold; generally speaking, the more financial eggs you have in one basket, the greater the risk. For example, if you put all your money in a single stock and it loses value, you will lose all your money. Market risk refers to the possibility of your investment value rising or falling because of market conditions. Even conservative, insured investments, such as certificates of deposit (CDs) issued by a bank or credit union, come with inflation risk. That is, they may not earn enough over time to keep pace with the increasing cost of living.
It is possible to manage investing risks by understanding the basics of risk and how it is measured. Learning the risks that can apply to different scenarios and some of the ways to manage them holistically will help investors to avoid unnecessary and costly losses.
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The unpredictability of the market
The main risk of investing is the possibility of losing money. The outcome of any investment is uncertain for multiple reasons, but the unpredictability of the market is a key factor.
The performance of a company's shares can take a turn for the worse, or economic issues can negatively affect the stock market more broadly. For example, stocks, bonds, mutual funds and exchange-traded funds can lose value—even their entire value—if market conditions sour. Even conservative, insured investments, such as certificates of deposit (CDs) issued by banks or credit unions, come with inflation risk. That is, they may not earn enough over time to keep pace with the increasing cost of living.
Risk is any uncertainty with respect to your investments that has the potential to negatively impact your financial welfare. Your investment value might rise or fall because of market conditions (market risk). The level of risk associated with a particular investment or asset class typically correlates with the level of return the investment might achieve. This means that investors willing to take on risky investments and potentially lose money should be rewarded for their risk.
However, it is possible and prudent to manage investing risks by understanding the basics of risk and how it is measured. Learning the risks that can apply to different scenarios and some of the ways to manage them holistically will help all types of investors and business managers to avoid unnecessary and costly losses.
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Inflation risk
Investment risk is the possibility of losing money, either partially or entirely. Investors who take on riskier investments should be rewarded for their risk. The main risk of investing is the possibility of losing money – you might not get back what you put in.
There are ways to mitigate inflation risk. One strategy is to invest in assets that are expected to increase in value at a rate that is higher than the rate of inflation. For example, stocks and property have historically outpaced inflation over the long term. Another strategy is to invest in assets that are protected against inflation, such as inflation-linked bonds, which increase in value in line with the inflation rate.
It is also important to consider the impact of taxes and fees on the real rate of return of an investment. For example, if an investor puts $1000 into a savings account with a 2% interest rate, but they have to pay 25% tax on the interest earned, then their real rate of return is only 1.5%. If the inflation rate is above 1.5%, then the investor is losing purchasing power over time.
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Liquidity risk
There are ways to mitigate liquidity risk. One way is to diversify your investments. By spreading your money across multiple investments, you reduce the risk of having all your money tied up in one investment that is difficult to sell. Another way to mitigate liquidity risk is to choose investments that are more liquid, such as stocks or mutual funds, rather than less liquid assets such as property or collectibles.
It is important to carefully consider the liquidity risk of any investment before committing your money. By understanding the liquidity risk, you can make more informed decisions about whether to invest and how much money to invest.
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Concentration risk
Risk is the possibility that a negative financial outcome will occur. All investments carry some degree of risk. The main risk of investing is the possibility of losing money. You might not get back what you put in. There is also the risk that you won't achieve your expected returns over a particular time period. The outcome of any investment is uncertain for multiple reasons, including the unpredictability of the market.
Liquidity risk is another type of risk that refers to how easy or hard it is to cash out of an investment when you need to. Market risk is the risk that your investment value might rise or fall because of market conditions. Inflation risk is the risk that your investment may not earn enough over time to keep pace with the increasing cost of living.
It is possible to manage investing risks by understanding the basics of risk and how it is measured. Learning about the different types of risk and some of the ways to manage them will help investors avoid unnecessary and costly losses. Risk is broadly categorized as the chance that an outcome or investment's actual gain will differ from the expected outcome or return.
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Frequently asked questions
The outcome of any investment is uncertain, and the performance of a company's shares could take a turn for the worse. However, taking investment risks could give your money the potential to increase in value above and beyond inflation.
Generally speaking, the more financial eggs you have in one basket, the greater the risk. The level of risk associated with a particular investment or asset class typically correlates with the level of return the investment might achieve.
Liquidity risk refers to how easy or hard it is to cash out of an investment when you need to.
Concentration risk refers to how many or how few investments you hold. The more investments you hold, the less risk you take on.
Market risk refers to the uncertainty of your investments' performance due to market conditions. Your investment value might rise or fall because of market conditions.
