You must never invest your money or financially plan without understanding what the different types of risk are. When people think about risk, they believe that its all about just losing money, which is known as capital risk. But this isn’t the only type you should be aware of. When you decide to make an investment, it’s difficult to say with complete certainty what amount of money you will actually make back. This is because interest rates can vary, share prices can go up and down, and inflation also has a significant influence too. However, this will typically depend on the type of investment you choose to make. If you choose shares, then their prices ultimately depend on what you make back. While if you decide that a high return investment is for you, then interest rates and inflation will affect your return. So, what are the different types of investment risks? We are going to go through each one during this short but insightful article. So, keep reading to find out!
This is a type of risk that is concerned with an investment made in a company. If the company run into financial difficulty during the term of the investment or when it matures, then this can affect the return.
Market risk is all about the economic state of the market at the time you take out the investment compared to when you receive your return. There are 3 different types of market risks. These are, equity risk, currency risk and interest rate risk.
Inflation risk is when the value of your investment(s) doesn’t keep up with inflation rates. Inflation risk is particularly important to be aware of if you own cash or debt investments such as bonds. Shares offer some element of protection against inflation rates because most companies can increase the prices they charge for their products and services. Share prices should, therefore, increase in line with inflation rates.
Longevity risk is a little bit different from the other types of investments that we discuss during this article. This type of risk is if you outlive your savings. However, it is more relevant to those who are nearing their retirement age or are already retired.
Horizon risk is when your investment might be cut short due to unforeseen circumstances such as losing your job. In this situation, you might have to sell the investment(s) that you were expecting to hold for the long term. And, if you are forced to do so and the markets you invested in are down then risk losing money as well.
Reinvestment risk will affect your return(s) if interest rates drop. For example, if you bought a bond that pays 10% and interest rates drop, then you might have to reinvest the interest payments at a lower percentage.
Foreign Investment Risk
This is a risk of loss when you decide to make an investment in a foreign country. For example, if you choose to buy shares in a company that are located in another country, then you face risks that do not exist in the United Kingdom.
Concentration risk is when all of your money is situated within 1 investment. You can avoid this type of risk if you diversify your investment across a range of different industries.
Conclusion: Think Carefully
When you choose to invest your money, you become exposed to a mixture of different risks depending on the type of investment you make. Being aware of the risks that are associated with a specific investment and weighing the potential returns against the potential risk is important for making a decision. This is the approach of strategic investing with risk awareness in mind. Ultimately, the best idea is to do your research and analyse the potential risks to understand if they fully justify the returns you expect to make back from your investment.