Almost all investments come with a certain degree of risk. Your money is safest when it’s in the bank. However, the opportunity cost of not investing is the attractive returns on investment you could have made.
So, taking on some risk is inevitable when investing. That said, always have an emergency fund saved up in your bank to tide you through rough times, should you encounter them.
Only invest with money you can afford to lose though the goal here will be to manage your risk. Like American economist, Benjamin Graham, said, “Successful investing is about managing risk, not avoiding it.”
Below you’ll discover some of the risks associated with investing. Take note of them, but don’t let them scare you. As long as you invest prudently, you’ll be fine.
What’s the difference between systematic risk and unsystematic risk?
Systematic risk
Systematic risk refers to risk which affects the entire economic market. This risk is also known as ‘volatility’ or ‘undiversifiable risk’. Generally, systematic risk arises due to macroeconomic factors.
The recent Covid pandemic is an example of systematic risk. It almost wiped out the airline, travel and several other industries. Natural disasters, inflation and other events which have a strong impact on many related markets cause systematic risk.
The best way to mitigate such risk will be to diversify your portfolio. For example, if you held stocks in airline and pharmaceutical companies, while the airline stocks plunged because of Covid, you’d have seen a rise in the stocks of pharmaceutical companies manufacturing the vaccine and so on.
Unsystematic risk
This type of risk only affects a particular industry or company. For example, when companies decide to ‘go woke’ and pander to social justice warriors, their stocks tend to inevitably take a hit after the masses boycott them.
This resulting drop in share prices usually only affects the company with the controversial ad campaigns or stances on social issues. Another example of unsystematic risk would be new competition which threatens to eat up a significant slice of the market.
New laws which affect a certain industry may also be seen as unsystematic risk. Once again, the best way to protect your investments will be to diversify your investment portfolio by holding a wide range of investments.
A few common risks
Now let’s look at the different types of risks…
Interest rate risk
This risk arises when a change in interest rate leads to a loss of money. The decline in the value of the asset is usually due to an inverse relationship between the interest rate and the price. One common example are bonds. When the interest rates on bonds rise, the price of the bond drops.
Currency risk
This affects forex traders the most. It happens when the value of a foreign currency you hold drops. For example, if someone in Australia puts his money in U.S. currency investments but the U.S. dollar is declining in value against the Australian dollar, he’ll make a loss.
The best way to mitigate this risk will be to hedge your investments wisely.
Inflation risk
This is a systematic risk where the value of your investment can’t keep up with the current rate of inflation.
Liquidity risk
This risk occurs when you want to cash out but you can’t sell your investment. The only way to sell it may be to accept a lower price than you want.
It’s for this reason, you should always have an emergency fund saved up. So you can use that if you need money. You can then wait out the liquidity risk and sell your investment at the right time.
Credit risk
This risk refers to a government or bond issues being unable to fulfil its obligations and pay out the principal upon maturity.
Political risk
This tends to affect long term investors because when governments change, the economy may decline or become unstable. As a result, share prices and the value of investments can decline considerably.
In conclusion
These are just some of the risks involved with investing. They’re a part and parcel of investing and come with the territory.
Do not hold yourself back from fear of loss. Do your research and invest wisely. This will ensure that you grow your money effectively and reduce risk in the process. That’s how smart investing is done.
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