Updated: Nov 23, 2021
Making a financial plan might seem to be scary for many people. The main reason is that majority of people are unaware of the nitty-gritty of this field. The fear of making investments can be minimized with dedicated study and research on various investment options. You can also seek professional assistance from investment advisors and managers. But one thing is common in all cases – investments come with their share of risks. Whether you are based in Houston, TX, or any part of the world, investment risks will always be there. The trick is to know about the risks and adopt ways of minimizing them.
What are Investment Risks?
Before we go into the different kinds of risks, we must first understand what investment risks are. For the majority of investments, there is no guaranteed rate of return.
Risks vary depending upon the kind of investment that you are making. Generally, investors expect a higher return for investments that present a higher risk of losing some or all the investment
Risks Involved in Investments
● Credit risks – The Cypress,TX company or organization which has issued the bonds might face financial difficulties. As a result of this, it is unable to pay the principal and the interest at maturity. Such credit risks are mainly applicable for various debt investments like bonds. If you want to evaluate the credit risk of a bond, you must check its credit rating. The higher the credit rating, the lower is the credit risk.
● Liquidity risks – This is one of the most crucial investment risks which you can face. Liquidity risk involves the inability to sell your investment at a reasonable rate. You could need money urgently, and you plan to sell your investment. But you fail to get good rates for the investment. You have no other option than to sell it at a lower price. Again, for some cases like exempt market investments, you will not be able to sell the investment at all.
● Inflation risks involve a loss in buying power as the investment value is not at par with the inflation rate. The purchasing power of money declines with inflation. You might pay the same amount of money and get fewer products and services. If you own bonds, debt investments, or cash, you are susceptible to inflation risks. Some investments and sectors may be less susceptible to inflationary risks
● Market risks – You may make any kind of investment, but they are always subject to market risks. There might be a decline in the value of the investments due to various events or economic developments taking place. Such events impact the whole market. Market risks can be classified broadly under interest rate risk, equity risk, and currency risk.
✔ Interest rate risk – This risk is mainly applicable for bonds and other debt investments. It involves the risk of losing funds with a change in interest rate. The market value of bonds drops when interest rates shoot up.
✔ Equity risk – The market price of shares keeps on changing all the time.
✔ Currency risk – This investment risk is not for all. It is generally applicable for individuals who have foreign investments. Exchange rates of foreign currencies keep on changing frequently. There is a high risk of losing money when exchange rates vary.
● Concentration risks – Many people tend to invest in one instrument only. For instance, some like to invest only in stocks, some trade only in bonds, and some are comfortable with fixed deposits. When investments are diversified, chances of risks are scattered as well. But it is also essential to keep track of all scattered investments.
● Reinvestment risks – Reinvestment risks are common. While reinvesting the income or the principal amount, you might have to settle for lower interest rates, causing losses. Suppose you purchase a bond paying 5%. If interest rates drop, you might have to reinvest at 4%, and this is where reinvestment risk comes into the picture. Reinvestment risk is utterly dependent on the current interest rates in the market.
● Political risks – We all know that the economic condition of a country affects investments on a large and small scale. Political risks comprise taxes, trade barriers, administration, and legislative issues. High political risks can be harmful to investments.
● Foreign investment risks – Many people are looking to make quick money with foreign investments. But this market is highly volatile, and hence the risks are high. These investments are mainly made in foreign lands. While purchasing foreign investments in the form of shares or other assets, you might face unknown risks. You might not have heard about such risks in your own country.
● Horizon risks – Unforeseen and unprecedented events are not uncommon in our lives. Your investment horizon might be shortened due to uneventful happenings. To combat such a situation, you might have to sell your investments forcibly. You had planned to hold this investment for the long term.
Financial professionals highly recommend you keep on reviewing your investments from time to time. You should also be aware of the current market situation. It will give you insights into the various investment risks you can face and prepare accordingly.