What are the major types of risks in investment?
all of us who invest in the stock market are looking for a risk-free investment which can generate good returns. However, it
is impossible to have a risk free investment. Investing in stock market is a risky
affair. Albert Einstein once said, “A ship is always safe at the shore,
but that is not what it is built for.” This clearly tells us that more the risk
an investor is willing to take, the more is the potential for higher returns.
are some risks on which you can have your control while others are beyond your
control. So an important aspect of investing in stock market is, understanding
the types of investment risks and identifying the ways to minimize the negative
effects of risks on your portfolio. In this article, we will talk about the
major types of investment risks. For an understanding
of how to manage risk, refer to our blog – 6 Ways to Reduce Stock Market
Risks. So let us understand the different types of risks that an investor faces;
but before that let us understand the meaning of risk.
risk is the possibility for an investor to experience a downside in
the overall performance of the stock market or the price of his stock in particular.
of Investment Risks
1. Market Risk
risk is also called as systematic risk. Market risk is the risk in which an
investor can lose due to factors or events that affect the financial market’s
overall performance. These factors include natural disasters, political
turmoil, changes in interest rates, terrorist attacks, inflation, recessions,
etc. Market risk impacts the entire economy and share market. It affects all
the stocks in the same manner and hence it is impossible to eliminate this risk
by diversification of the portfolio. The
main types of market risks are currency risk, equity risk, interest rate risk, etc.
2. Specific Risk
risk is also called as unsystematic risk.
As the name suggests, specific risk is
specific to a particular industry or company. It does not affect the entire
market. Here an individual company or small group of companies can have
problems like product failure, incompetent management, employee strike, new
government regulation affecting a particular group of companies, etc
which leads to fall in the price of the stock
of that company. However, one can eliminate specific risk by diversification of
3. Volatility Risk
risk is the possibility of change in the price
of the portfolio due to volatile factors. It can be majorly seen in derivative
instruments where the price of derivative instruments changes due to volatility in it's under lying asset. In simple words, it is
the amount of uncertainty or risk of changes in a security's
value over a short time period in either direction.
4. Interest Rate Risk
risk is the risk of losing money due to change in the rate of interest.
Interest rate risk majorly impacts debt investments such as bonds or NCDs.
There is an inverse relationship between interest rate and the price of bond -
when the interest rate goes up, the price of bond declines and vice versa. However, one can reduce the impact of this
risk by holding the bonds until maturity.
5. Default Risk
Default risk is
also called as credit risk. It is the risk of non-payment of principal and
interest amount by the borrower. This is one of the most infringed risks
especially in the case of unsecured loans
as they are not secured against any security. Hence it is advisable to look at
the credit ratings of the company before you invest your hard earned money in
company deposits or debentures.
6. Inflation Risk
a general increase in prices with a fall in purchasing power. In simple words,
when prices shoot up, the purchasing power of your money goes down. You will
now be able to purchase fewer goods and services with the same amount of money.
Inflation risk is the risk of losing the purchasing power of your investments.
Inflation risk majorly impacts debt investments like bonds and hard assets like gold and commodities.
7. Reinvestment Risk
risk is the risk of loss arising due to reinvesting the principal or interest
amount at a lower interest rate. Let us say, you bought a bond paying 5% and it
is about to mature. Now the interest rates drop and if you reinvest the amount
at 3%, it will amount to reinvestment risk. However, you can escape the
reinvestment risk if you intend to spend the amount at maturity.
8. Liquidity Risk
Liquidity risk arises when an investor is not able to find a buyer for
the asset he is holding. Generally, the
equity and bonds are liquid. The buyers for them are easily available. However,
assets like old stamps, coins, real estate, art work, etc. do not often have
buyers for them. This makes these assets illiquid. When the owner of such
assets needs money, he has no other option but to sell them at a fairly lower
price after suffering substantial losses. The best way to overcome such loss is
to wait for the right buyer or borrow money from banks/financial institutions
if funds are needed urgently.
9. Political Risk
Political or regulatory risks are the risks associated with the economic
environment and government policies related to different matters of the
country. Whenever government frames a policy that is unlikely to receive a positive reaction from the respective sector of
the economy, it leads to the downfall in
the prices of the shares of that sector. Similarly, when the government
changes, the new government comes with new economic policies and agendas
leading to instability and change in economic ideology. This creates panic
among the investors leading to selling of the shares and ultimately leads to
the downfall in price. However, one can
overcome this risk by not falling prey to the panic and holding the shares in
the portfolio. Wait and watch is ideal in such scenarios.
The Bottom Line
These are some of the major types of investment
risks in the stock market. Coming back to
the same point, there is no such thing as a risk-free stock or investment. As
an investor, the best thing you can do is analyse
the risks before you buy a particular stock, review your existing investments
and figure out which risks really affect you. You must also consider the amount
of risk that you are comfortable to take. All said and done, even though every
stock faces some or the other risks, the rewards of investing can still far
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