Risks are an integral part of investing. Any worthwhile investment opportunity comes with several risks. However, when a businessman or investor understands how risks work, they can manage different investment risks and prevent costly or unnecessary losses.
Risks inform a business owner of the possibility of losing some or all of their investments. In the financial industry, risks are defined as the chances that the eventual yield on investment capital will differ from the projected or expected yield. Investment risk highlights the discrepancies between hypothetical and actual returns.
There are several risks associated with investments. Here are four crucial risks to know as an investor:
Company risk is the risk associated with owning individual stocks in a company. An overall company loss will result in monetary losses for investors owning individual stocks. In some cases, a company may report overall great sales but unconvincing profits across a business year.
Inept management structures can result in an undervaluation of a company’s worth. When stocks drop, the value of an investment takes a hit. Before purchasing stock in any company, research the company’s reports over the last two to three years, review their quarterly turnovers. Consult with market analysts and consider the comments of other investors.
Diversifying your investment is another great way to manage company risk. Purchase several stocks in a company or across different companies. The more shares you own, the better your chances of earning a profit.
Market risks are subject to the demand and supply of the economy at a particular time. These risks are independent of a company’s performance and arise due to the volatility that governs any financial market.
Market risks are of several types:
- Commodity Risk: Select commodities such as oil or foodstuffs are pivotal to the growth of any economy, such that a change in the prices of these goods will affect the performance of most other products in the market.
- Exchange Rate Risk: A currency can decline in trading value when the currency depreciates in domestic value. Investors who purchase international investments are liable to experience this risk.
- Interest Rate Risk: The central bank regulates interest rates through monetary policy measures. An increase in the market rate on a particular bond, X, will trigger a decline in the demand for a bond, Y, with a lower market rate. This could yield losses for Y investors.
The easier it is to exchange an asset for another, the lower the risks associated with owning that asset. Different liquidity risks mark different assets. Cash, for instance, is a highly liquid asset and can be traded off within a few minutes. At the other end of the spectrum are assets such as real estate, which could take several months to a few years before they are exchanged. These kinds of assets are considered illiquid assets.
Before purchasing illiquid assets, ensure you have enough liquidity in other assets to balance your financial needs through any given season.
The price of goods and services fluctuates at different times. When the value of an investment doesn’t keep up with inflation, the investor bears inflation risk. Inflation affects the value of money over time. An increase in the cost of gas, for instance, reduces how much gas you can buy with $20.
To prevent inflation risks, invest in assets whose prices depend on the owner and not the market or government. The value of a bond, for instance, will not adjust to inflation rates. However, real estate owners can increase rent to keep up with inflation.
While research should precede any investment, you can’t foresee the future market. Continuous learning about the market and different risks will prepare you for the uncertainties of investing.