• May 23, 2018

Tricks to Understanding Investing Risks

Even if you are not a financial expert, you would know that all investments come with a degree of risk. This can vary from very high to very low depending on the type of asset you are investing in, but how exactly do you determine whether an asset is very risky or not?

It’s important to understand that risk is not an overall factor. There are different ways risk can affect an investment asset. In general, risk is understood in terms of how quickly or speedily money grows, how safe the investment is in the market, and how quickly investments can withdraw returns. These factors can vary depending on the type of risk. If you are a new investor, here is a list of risks you should expect your investments to face:

Business Risk

This refers to the company’s ability to stay afloat. Investors who buy stock are buying a percentage of ownership in that company. Unlike bondholders who lend money to companies, stockholders bear the brunt of a possible failure. If the company goes bankrupt, stockholders will lose money just like the top brass of the company. That’s why it’s important to assess the financial standing of a company before investing. Even if you are day trading, it’s important to understand the business risk to estimate the true value of a stock.

Inflation Risk

Inflation of a currency leads to all prices generally going up. That means less liquidity. Inflation can reduce the fixed rate of interest on some types of investments. In simple terms, inflation can reduce the returns on cash investments. Investors generally have to watch out for the inflation when purchasing assets like treasury bonds and securities.

Liquidity Risk

Liquidity refers to being able to sell an asset, like a stock. Inability to sell, or illiquidity, can lead to investors holding on to relatively worthless assets. For example, penny stocks come with high liquidity risk. Because just about everyone considers these stocks to be worthless, investors who are not careful could end up with a lot of stock that’s worth nothing. Assets that cannot be sold or bought early without a penalty, such as certificates of deposit before maturity, also carry high liquidity risk.

Interest Rate Risk

The interest rate here refers to the rate adjusted by the Federal Reserve or the Central Bank abroad. If the interest rates are high, investors would naturally enjoy higher returns on assets like bonds, but when the interest rate lowers, the same assets lose value. Investors should keep an eye on the factors that lead to interest rate hikes, such as low demand or downgrading of a company’s credit rating.

Market Risk

This refers to the volatile nature of stock prices. Market fluctuations are caused by many factors. Some are easy to spot, such as products losing quality and the subsequent demand decrease from the consumer side. But hard to predict political or macroeconomic factors can also cause stock prices to dangerously sway.

Once you understand the risks, it’s important to manage risks when making investment decisions. Risk should always be considered against rewards. The ideal investment is low-risk and high yielding, but these types of investments can be difficult to find given the above risks facing all types of investments. However, investors can seek certain guarantees and security when investing, such as paying for secured bonds or stocks rather than taking on more risk.

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