Finance

The Ultimate Guide for Understanding Investment Risk & Its Types

The idea of a risk-free investment is a myth. All modern business sectors involve a certain level of risk. So managing such a risk has become more of an essential skill in recent times. Given that people are growing fond of earning money which increases the need for making greater leaps into diversified financial sectors.

Many would have probably heard of the term “risk” that denotes the uncertainty in the effort that may or may not result in a potential financial loss. It is nothing wrong to be more aware of such factors when you are looking for a leading a successful business life.

Though this idea of risking has become common practice, not all such efforts turn out to be a smart choice. So it is always better to understand all these fancy risk terms before getting ourselves into it. This article will discuss on the following terms:

  • Why it is important?
  • Types of investments
  • Types of Investment Risk
  • Methods to overcome the risk factors

Why it is important?

Understanding the investment risk gives the upper hand on predicting the feasible cash flow in the business. It helps in avoiding unwanted hassles and to focus more on the end goal.

It is not possible to avoid such risks 100% but this idea of understanding investment risks proves way more useful in case of making huge capital funding. So it all begins with knowing the various types of these investment risks and the best effective methods to overcome them.

Types of investments

The nature of investments tends to change over time. Today there are four popular assets over which the idea of investment and their associated risks are calculated.

Cash:

This is the most common and the least risk factor among the four. So it is more obvious that it offers low returns and the value could be greatly reduced in terms of the high inflation.

Bonds:

It is a little riskier when compared to cash. It involves the certain government bonds and in the majority of cases people lend money to big organizations and hence the name “corporate bonds”. Here the Money borrower organization has to pay a certain rate of interest for a fixed period of time.  There is another term called Junk Bonds which are high yield bonds and are way more risky than the previous one.

Property:

The thought of investing in land or a property sound smart. Well, it is, it provides a great opportunity to multiply your money over a certain period of time. But one must say it could become quite a hard one when the individual is in need of liquid money in hand.

So if you are not in any such hurry, these are the best choice one could make but be aware of the scammers in the market.

Shares:

Given the modern financial markets range shares or equities are the best way to make easy money if you know what you are doing. As long as it sounds profitable the stock markets are quite unpredictable as you know it, one small mistake could drag you to the bottom. So, one must choose the right one.

It is also said that US and UK markets are safer when compared to other equity markets. So steady the market before making a move. If this sounds too hard you could also seek professional help from expert’s advice to make a wise choice.investment risks

Also Read: Best Financial Trends to follow in 2019

Types of investment risks:

The investment risks are of various types but to make it simple and easy to understand they are grouped into two main categories: Business risks & Market risks.

Business Risks:

The business risks are referred to as the Non Systematic risks as they involve making investments in any of the particular brand, product or an organization.

This involves,

Management Risk:

As the name indicates it involves managing the risks in the day to day business operations. This could include the market fluctuation of the company’s product or service. Losing critical resources, making contingency plans to meet the debt settlements and etc. Such risk factors tend to vary among different organizations and their respective sectors.

Credit Risk:

It involves bonds and their relative interest payments. As mentioned earlier this could become quite an issue. So, one must pay greater attention to collecting the interests without fail as it could affect the financial status of any organization.

Market Risks:

This represents the overall risk exposure to all the investments when the market declines. The individual strength and weakness have a No say in it.

There are numerous factors that affect such market rate which is explained below

Currency Risk:

When it comes to international trades the currency exchange rate plays a vital role in defining the market value. Any change in such exchange rates could impact the market on a greater level.

Country Risk:

Any change in the government norms and policies could also affect the rightful investment made. So, one must be well aware of their trading partners.

Interest Rate Risk:

This involves bonds. When there is a change in the interest rates for the lent money this could greatly affect the bonds. When the interest rates fall the bond value increases and conversely when the interest rate increases the previous bonds fail.investment risks

Also read: Things to know about Business loans and its types

Sociopolitical Risk:

This involves the occurrence of any social events or political issues such as elections, war, terrorism etc. in a country which could influence the market to a greater level.

Liquidity Risk:

Here one cannot buy or sell any property for its true market value due to the lack of buyers in the market.

Inflation Risk:

This is also known as the purchase power risk, as the price of the goods and services increases it reduces the purchasing power of the money. This indeed affects the value of the investments. Inflation risk is related to interest rate risk. When the inflation is high it increases the interest rate and when the inflation is low the interest rates also tend to decrease.

Legal remedies Risk:

This refers to getting the required legal support to handle various local issues that arise in the foreign country during the investments. Such risks tend to vary among different countries.

Concentration Risk:

It denotes the practice of paying too much attention to the particular sector of investment. i.e Many people tend to believe that making huge investments on any of the well-known sectors could result in profit. This does not work well all the time resulting in some great losses too. So it is advisable to spread the investments in various sectors.

Reinvestment Risk:

Such a condition occurs when an investment term expires due to falling interest rates and there are no similar opportunities available. So to reduce such a risk it is advised to diversify the investment in multiple sectors with various maturity dates. One must also look for new investment options regularly.

Longevity Risk:

Here is risk involves outliving your savings. This is a more common fear among retired individuals. So it is better to make smart retirement plans for a happy living.

Simple Rules to be “Smart Investor”

  1. It becomes paramount to understand that risk is directly proportional to the return you get. Smaller the return then smaller is the risk involved. So be more conscious of what you choose.
  2. Risking all of your money to get the bigger fish might be more tempting but remember Risking also involves losses. So, one bad step could cost you all your money. It is better to take time to analyze the given situation and to make the right choice.
  3. If the investment is Short term it is better not to take greater risk. So plan accordingly be more thorough on how much you invest and when do you plan on harvesting the return money.
  4. If the investment is for a Long term you can surely make the capital risk. This is because you will have more time to recover or to plan for passive income ways.
  5. Share-based investments are the best possible options. Even though it involves a fair amount of risk yet if the plan is for a long term it provides the required chances of recovery from the stock market failures.
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