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Types of risks involved with investing in stocks, bonds, and real estate.
Have you ever wondered exactly how much risk is involved with the investing? It never fails, when I have new clients coming in, they say they want all of the upside but none of the downside. Basically, they want their cake and to eat it too. However, the problem is you can't invest without taking some risks. We face a variety of risks when investing route. So today I'm going to go over what those are and how you can deal with them.
Types of Risk Involved with Investing
1. Market risk
The risk of investments declining in value because of economic developments or other events that affect the entire market. The main types of market risk are equity risk, interest rate risk, and currency risk.
Equity risk – applies to an investment in shares. The market price of shares varies all the time depending on demand and supply. Equity risk is the risk of loss because of a drop in the market price of shares.
Interest rate risk – applies to debt investments such as bonds. It is the risk of losing money because of a change in the interest rate. For example, if the interest rate goes up, the market value of bonds will drop.
Currency risk – applies when you own foreign investments. It is the risk of losing money because of a movement in the exchange rate. For example, if the U.S. dollar becomes less valuable relative to the Canadian dollar, your U.S. stocks will be worthless in Canadian dollars.
2. Liquidity risk
The risk of being unable to sell your investment at a fair price and get your money out when you want to. To sell the investment, you may need to accept a lower price. In some cases, such as exempt market investments, it may not be possible to sell the investment at all.
3. Concentration risk
The risk of loss because your money is concentrated in a particular type of investment. When you diversify your investments, you spread the risk over different types of investments, industries, and geographic locations.
4. Credit risk
The risk that the government entity or company that issued the bond will run into financial difficulties and won't be able to pay the interest or repay the principal at maturity. Credit risk applies to debt investments such as bonds. You can evaluate credit risk by looking at the credit rating of the bond. For example, long-term Canadian government bonds have a credit rating of AAA, which indicates the lowest possible credit risk.
5. Inflation risk
The risk of a loss in your purchasing power because the value of your investments does not keep up with inflation. Inflation erodes the purchasing power of money over time – the same amount of money will buy fewer goods and services. Inflation risk is particularly relevant if you own cash or debt investments like bonds. Shares offer some protection against inflation because most companies can increase the prices they charge to their customers. Share prices should, therefore, rise in line with inflation. Real estate also offers some protection because landlords can increase rents over time.
6. Horizon risk
The risk that your investment horizon may be shortened because of an unforeseen event, for example, the loss of your job. This may force you to sell investments that you were expecting to hold for the long term. If you must sell at a time when the markets are down, you may lose money.
7. Longevity risk
The risk of outliving your savings. This risk is particularly relevant for people who are retired or are nearing retirement.
8. Foreign investment risk
The risk of loss when investing in foreign countries. When you buy foreign investments, for example, the shares of companies in emerging markets, you face risks that do not exist in Canada, for example, the risk of nationalization.
9. Call Risk
This is a risk for bond issues and refers to the possibility of a debt security being called before maturity. This typically takes place when interest rates are dropping.
11. Social / Political Risk
The risk associated with the possibility of nationalization, unfavorable government action or social changes resulting in a loss of value is called social or political risk.
These are just a blip of the different types of risk that are involved with investing. You can experience any of these at any time! I tell you all that because investing is complicated, which is why I implore you to hire a CERTIFIED FINANCIAL PLANNER™. Making that choice could help make your life financially simple. Contact us if you have questions about these or any more of the risks involved with investing.
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