Understanding the Risks of Investing

“With great risk comes great reward.”  So the saying goes.  While we might be willing to take big risks in life and in business for great reward, we seldom have the same willingness when it comes to our money.   When it comes to saving and investing we tend to want as much return as possible but with as little risk.

Not many of us have the stomach for losing our money. So it is no surprise that when it comes to saving and investing the risks associated are often the most concerning piece. Truthfully, how many of you look at your investment statement and just note whether it went up or down. If it went up, you think you’re doing well.  If it went down, you question whether your strategy is working. There’s more to managing investment risk than just evaluating your periodic investment return, whether it’s up or down at the time you look at it.

Understanding the various types of risk that may affect your savings and investments can help you better determine if your strategy is working for you.  You’ll also better understand a strategy recommended by a professional advisor.  Remember, the goal here is to make you more informed thus making you more comfortable in the financial decisions you make.

So let’s talk about some of the risks associated with saving and investing.

Inflationary Risk is the chance that your money today will not have the same purchasing power in the future.  It means that if you don’t earn interest (or enough interest) today, you won’t be able to buy as much 10 years from now because the cost of goods like groceries and gas goes up over time (inflation).  This is why when you invest over a long period of time it’s essential to earn a return that at least keeps pace with inflation to avoid losing money (the future value of that money.)

Business Risk is risk specific to either one type of business or one particular company.   For example the risk that American Airlines could go out of business due to their own mismanagement.  This is why it is so important not to hold too much of any one company.

Market Risk is different from business risk in that market risk is related to the general economy or market and is affecting companies in a similar way regardless of how financially strong a company may be.  For example, all airline companies likely suffer in a poor economy.  You could even broaden that category to include all travel and leisure associated companies.   The poor performance of the company’s stock isn’t due to the actual company’s decisions; rather general market pressures are affecting it.

Liquidity Risk speaks to how quickly you can buy or sell an investment.  You might be comfortable investing in real estate (actually purchasing property) but you have to consider how quickly you could sell it to raise cash.  Other physical assets fall into this category, such as timber, gold, art, and collectibles.

Reinvestment Risk is specific to bonds or CDs.   It’s the risk that when a bond matures or a CD renews that the interest rate will be less than what you originally were earning.

Now that you have a basic understanding of these general risks in the next post we’ll focus on how various investment vehicles and strategies are used to offset these risks.


Next up…

The Big 3: Stocks, Bonds, & Cash

Size Matters! (Especially when it comes to investing.)