7 Investment Risks Investors should take note of

As an investor, you invest to earn a decent return on your money, but returns are not the only consideration.

Risk and return are deeply intertwined, and investors should understand and seek to mitigate the different risks involved too. Here are 7 main types of investment risks that can derail your investment returns:

1. Market risk

Market risks spells out the risk of investments declining in value because of economic developments or other events that affect the entire market.

The 3 main types of market risk are equity risk, interest rate risk and currency risk

Equity risk – applies to an investment in shares. The market price of shares varies all the time depending on demand and supply. Equity risk is the risk of loss because of a drop in the market price of shares.

Interest rate risk – it is the risk of losing money because of a change in the interest rate and is usually inversely related. This has taken the recent spotlight as the U.S. Fed is hiking up rates to tamper with soaring inflation.

Currency risk – applies when the company you own have foreign assets and liabilities. It is the risk of losing money because of a movement in the exchange rate.

2. Liquidity risk

The risk of being unable to sell your investment at a fair price and get your money out when you want to.

Liquidity risks is a big tumbling block for small cap stocks which can see low volume trading and investors need to accept a lower price to sell the investment. In some extreme cases, it may not be possible to sell the investment at all.

3. Concentration risk

The risk of loss because your money is concentrated in 1 investment or type of investment. When you diversify your investments, you spread the risk over different types of investments, industries and geographic locations.

4. Credit risk

The risk that the government entity or company that issued the bond will run into financial difficulties and won’t be able to pay the interest or repay the principal at maturity.

Although credit risk applies to debt investments such as bonds, you have to assess a firm’s credit risk because it may swerve into bankruptcy if mis-managed.

One good example is the water treatment firm Hyflux which fell from grace as its debts balloon and cash flow dries up together with the drought in orders.

5. Inflation risk

Inflation risk refers to the risk of a loss in your purchasing power because the value of your investments does not keep up with inflation.

Inflation erodes the purchasing power of money over time – the same amount of money will buy fewer goods and services. Inflation risk is particularly relevant these days due to the supply chain disruptions and on-going Russia-Ukraine conflict.

Producing firms or companies with pricing power generally offer some protection against inflation because they can increase the prices they charge to their customers. Real estate could offer some protection because landlords can increase rents over time too.

6. Horizon risk

This pertains to the risk that your investment horizon may be shortened because of an unforeseen event such as the loss of your job or property downturn.

This may force you to sell investments that you were expecting to hold for the long term. If you must sell at a time when the markets are down, you may be forced to realized your losses.

7. Foreign investment risk

Not to be mis-understood for FX risks, foreign investment risks stem from the dangers of investing in foreign countries. For example, if you buy shares of Alibaba Group ADR, you could be caught off-guard by China’s regulatory risks despite the company’s strong economic moats and financials.

Conclusion

The 7 main risks mentioned above is not an all-inclusive list. Each specific investment approach and product will have its own specific risks and risks will vary.

All in all, the important takeaway here is to be aware of the risks involved so that you can manage them and grow your nest egg with confidence.