Every investment carries some degree and type of risk. Since there are different types of risk, owning different investments in a portfolio can have a neutralizing effect. Remember, diversification of risk does not guarantee against loss, but it can have the effect of reducing the overall level of risk.
THE 2 RISKS INVESTORS MOST OFTEN CONSIDER:
Specific risk has to do with things that can go wrong with one particular investment, regardless of how well the overall market is performing. Factors might include the departure of key managers, unanticipated property damage, embezzlement, lawsuits, patent expirations, or product failures—all things specific to this one company.
Market risk refers to the chance that adverse events could affect an entire industry or area of the economy, in turn affecting the companies in which you are invested (even if those companies are doing everything right).
THE 5 RISKS INVESTORS OFTEN OVERLOOK:
When you own shares in a fund or other managed account that includes many different securities, there is always the risk that the manager will make poor choices—or that a star manager will be lured away to take a more lucrative position, leaving a less experienced or less knowledgeable manager to take over.
If you’ve chosen investments whose managers follow a certain style in selecting securities, there’s a risk that style will go “out of favor.” During certain periods, for example, growth investing was most popular; at other times, value investing prevailed.
Inflation causes the purchasing power of dollars to fall, and there always exists the risk that the growth rate on your investments might prove to be less than the rate at which the cost of living has increased. While all investments are subject to this risk, those with guaranteed principle and fixed interest are most vulnerable to the risk of loss of purchasing power.
Interest rate risk
Interest rate movements affect all types of investments, but the price of bonds will be most sensitive to changes in overall interest rates. Another aspect of interest rate risks, particularly for those dependent on investment income, has to do with maturity. A fixed-dollar investment (CDs, bonds, preferred stocks, etc.) bought years ago and maturing today might need to be replaced with a much lower-yielding investment.
Investors concerned with interest rate risk might want to consider real estate investment trusts (REITS). For more information about REITS, visit Sheaff Brock REIT.
When you need to sell an investment, penalties for early withdrawal might apply. The price of your investment might be depressed precisely at the time you are forced to cash it in.
2 LESSER-KNOWN RISKS:
Investments abroad decline in value for U.S. investors when the dollar rises in value against the currency of other countries; the opposite happens when the dollar weakens. Potential profits on investments abroad will need to be “translated” into dollars in order for you to realize spendable income. But even if you’re invested in only U.S. based companies, those companies may be operating on a multi-national level, subjecting you to currency risk.
Aside from currency fluctuations, events abroad certainly affect investments. Wars, political upheavals, and even natural disasters can also have negative effects on investments.
The old adage “Don’t put all your eggs in one basket” may well be another way of saying that investing is a mixed bag of risks.