Welcome to the topic Types of Investment Risks.
- Market Risk
The risk is that investments will lose value because of economic developments or other market-wide events. Interest rate risk, equity risk, and currency risk are the three main types of market risk.
- The term “equity risk” refers to the dangers of investing in stocks. The market price of stocks fluctuates all the time, depending on supply and demand. The risk of losing money due to a drop in the market price of shares is known as equity risk.
- Interest rate risk is a risk associated with debt investments such as bonds. It is the risk of losing money due to an interest rate change. If the interest rate rises, for example, the market value of bonds will fall.
- When you own foreign investments, you are exposed to currency risk. It is the danger of losing money due to a fluctuation in the exchange rate. For instance, if the US dollar depreciates against the Canadian dollar, your US stocks will lose value in Canadian dollars.
- There’s a chance you’ll run out of cash.
The risk of not selling your investment at a reasonable price and withdrawing your funds when you need them. To sell the investment, you may have to accept a lower price. The investment may not be sold at all in some instances, such as exempt market investments.
- The danger of concentration
You run the danger of losing your money since it is concentrated on one investment or type of investment. You spread your risk over several asset classes, industries, and geographic regions when you diversify your investments.
- Risk of reinvestment
You run the risk of losing cash if you reinvest capital or revenue at a lower interest rate. Assume you’ve purchased a 5% bond. Reinvestment risk exists if interest rates fall and you have to reinvest your regular interest payments at 4%. Reinvestment risk exists if the bond matures, and you must reinvest the principal at a rate less than 5%. Reinvestment risk does not apply if you expect to spend the regular interest payments or the principal at maturity.
- Credit danger
The possibility is that the government entity or company that issued the bond will face financial difficulties and be unable to pay interest or repay the principal at maturity. Bonds, for example, are subject to credit risk. The credit rating of the bond can be used to assess credit risk. Long-term Canadian government bonds, for example, have a AAA credit rating, indicating the lowest possible credit risk.
- The threat of inflation
The possibility of losing purchasing power as the value of your investments fails to keep pace with inflation. Over time, inflation erodes money’s purchasing power, resulting in the same amount of money buying fewer goods and services. If you own cash or debt investments such as bonds, inflation risk is especially important. Because most companies can raise the prices they charge their customers, shares provide some inflation protection. As a result, stock prices should rise in lockstep with inflation. Because landlords can raise rents over time, real estate provides some protection.
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