Identifying The Types Of Investment Risk and How to Manage Them
Looking for ways to make your money work for you and wondering what types of investment risks to expect? You’re already ahead of the pack — now it’s time to clue yourself up.
If you’re thinking of investing in a new opportunity, you probably have two questions at the front of your mind: what kind of returns can you expect, and how much risk is involved? Understanding the types of investment risk will help you formulate a strong financial strategy.
The first principle is that all investments carry an element of risk.
As a general rule, if there’s a chance your money could grow, there’s also a chance of its value decreasing. But don’t let that hold you back—just make sure you understand how to analyze different types of investment risk and make the right decision for your circumstances.
There’s no surefire way to ensure your investments will increase in value, but that doesn’t mean that every opportunity offers the same levels of risks and rewards. We’ll outline why investing always involves some risk, the types of investment risk you might encounter, and how to account for risk in your investing strategies. Ready to dive in?
Risk is an inherent part of investing
As we’ve touched on already, risk and investing always come hand in hand—you can’t have your cake and eat it too. Think about it: every time you invest in something, you’re effectively either lending money out or “betting” on a company’s success by funding it. It’s simply not possible to eliminate any chance of that firm failing or that borrower defaulting.
This is exactly why returns are possible in the first place. When an individual or company needs money, they offer returns to incentivize investors to part with their cash; nothing can do that quite like the allure of growing their money.
In effect, risk is what makes investing tick.
The higher the risk, the bigger the payoff. Few people would choose to invest in cryptocurrencies (high-risk) instead of government bonds (low-risk) if the two assets offered the same returns; higher risks require greater earning potential.
Successful risk management
Basically, if an investment opportunity included no risks at all, it probably wouldn’t offer any returns.
Even if you leave your money in a checking account, there’s a risk of it falling foul to runaway inflation.
But this doesn’t mean you should avoid all risks; it just means you should learn how to manage them. One of the best ways to do this is by collating a diversified portfolio, which involves investing in various asset types that carry different risk levels. That way, if one market crashes or one investment performs poorly, you still have your other assets to fall back on.
It’s also important to research the risks involved in different opportunities and decide how much risk you’re prepared to take on. There’s far less chance of a blue-chip stock failing than there is of a new startup going bust, for instance—but where you draw the line is up to you. Some people like to opt for low-risk investments, while others are happy to invest a percentage of their portfolio into riskier options.
Need some help figuring out what types of investment risks you should be looking out for? Let’s jump in.
Types of investment risks
If you understand how risk works and you’re still prepared to invest your money, it’s time to get a little more specific about what we’re dealing with.
There are many types of investment risks, and some of them you’re never likely to have to worry about, but here’s a comprehensive list of some of the more common ones.
When your investment acts as a loan, there’s always a chance that the borrower won’t pay you back, known as default risk. Although you can minimize default risk by exclusively lending to borrowers that seem creditworthy, it’s impossible to predict the future.
Business and financial risk
Business risk relates to a company you’re investing in, so it doesn’t apply to all kinds of investment (such as peer-to-peer lending). The more stable a firm’s income is, the lower the business risk, meaning companies offering essential goods or services with a consistent price tend to be safer bets.
Financial risk is similar to business risk but refers strictly to financial structure; think liabilities, cash flow, and income sources. It’s most applicable to businesses but also applies to individual borrowers and the government.
Investment manager risk
Certain types of funds are handled by investment managers (such as institutional investors), and as with all things, some managers are more capable than others. Signing your money over to the wrong person could cost you dearly.
However, index funds and many mutual funds are passive, meaning they aren’t subject to investment manager risk.
Interest and exchange rate risk
Interest and exchange rates have a huge impact on the economy, so it shouldn’t be a surprise they can also impact your investments. When interest rates rise, bonds become less valuable as better rates can be found elsewhere (e.g., high-yield accounts). Stocks may also lose value since borrowing becomes more expensive and curbs their growth.
Meanwhile, exchange rates alter the price of imports and exports, as well as foreign investments, which can seriously affect the profitability of some companies and the value of certain commodities.
Other types of risk
Other less common types of risks you might want to be aware of include:
- Political risk: Significant political events like presidential elections and the pandemic show that politics negatively impacts the stock market when there’s uncertainty.
- Liquidity risk: The risk of not being able to sell your investment quickly and at a good price.
- Tax risk: If you invest in a business that hasn’t dealt with taxes correctly, this could impact your investment.
- Reinvestment risk: Certain types of investments could get reinvested into something less profitable, particularly if you’re investing over a long timeframe.
- Inflation risk: When inflation is high, money and assets lose value, which can reduce your returns.
Investing with MyConstant
Hopefully, reading all this hasn’t made you scared you’ll lose every last penny you have and has instead left you feeling buoyed with the power of knowledge. Once you know the types of investment risks that are out there, you can start planning for them.
As a beginner investor, you might want to begin with an easy-to-use, relatively low-risk platform. MyConstant is one such solution, and we have a proud record of no investors losing their initial investment to date. You have two options with our platform:
You could try depositing money online to earn steady interest with minimal risk.
Your second option is to lend money or crypto to borrowers and businesses if you’re prepared to try something slightly riskier.
Either way, benefits include:
- 4% APY, compounded and paid every second
- No fees
- Anytime withdrawals
- Minimum investment just $10
- No maximum investment limit
Sound interesting? Sign up for a free account today and start investing.
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