Defining investment risk types
September 7, 2004
by Carol Perry
If I ask any two investors how they feel about risk, I will probably get two different answers. However, they are likely to agree that risk inevitably will come into play, both in selecting and reassessing their portfolios.
I thought it might be time to define the different kinds of risk when it comes to making an investment decision.
Risk is the unknown, the uncertainty tied to any investment decision. Since none of us can know the future, risk is always a factor in the decision making process.
Here are some of the various forms of risk. I will try not to get too technical.
— MARKET RISK
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Market risk is the likelihood that the value of an investment will change because of fluctuation in financial markets.
— INTEREST-RATE RISK
Interest-rate risk results from the fact that interest rates can and do change, directly affecting the value of the investment. This is especially true in bond funds.
— INFLATION RISK
This is a big one that is commonly overlooked. Inflation risk is the possible erosion of your purchasing power. An investment must yield a rate of return that exceeds the current rate of inflation and taxation to be considered profitable. Low yielding fixed-income investments that are secure in principal can actually be a negative return.
— ECONOMIC RISK
Economic risk concerns the strength or weakness of economic growth and its impact on investment return.
— POLITICAL RISK
Political risk is the possibility that domestic or global political events may affect the stability of return on an investment. This has become more prevalent in recent years.
— ILLIQUIDITY RISK
Illiquidity risk is the possible absence of a buyer (or market) in the event that you are forced to sell. This typically affects real estate and collectibles.
— RISK VS. REWARD
It is crucial to develop an investment mix that is suited to the level of risk you are willing to assume. The point that you stand on the risk vs. reward spectrum depends on variables like age, family situation, current and expected future income, tax bracket and overall net worth.
When you bring these all together, your investment objective should be a blend of assets that match your risk tolerance, lifestyle and long-term needs. After all, you want to make sure that your portfolio is working for you today and tomorrow.
A financial advisor can help you to establish your investment goals and assist you in continually appraising risk as well as performance. This should help you to maintain a well balanced portfolio.
If you would like more information on risk, e-mail me at firstname.lastname@example.org or call me at 841-4277.
Carol Perry, a Northern Nevada resident since 1983, represents the firm of Edward Jones Investments in Carson City.