Ten Types of Investment Risk: Finance 101

It never fails—when I have new clients coming in, they say they want all of the upside but none of the downside. Basically, they want their investment cake and to eat it too. However, the truth is you can’t invest without taking some risks. You need to understand the types of risk in investing that warrant concern and the types that are best left to the experts to worry about. Let’s discuss the types of investment risks and their causes.

The Top Ten Types of Investment Risks

1. Market Risk

The risk of investments declining in value because of economic developments or other events that affect the entire market. The 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 supply and demand. Equity risk is the risk of loss because of a drop in the market price of shares.
• Interest rate risk – applies to debt investments such as bonds. It is the risk of losing money because of a change in the interest rate tied to bonds. For example, if the interest rate goes up, the market value of bonds will drop.
• Currency risk – applies when you own foreign investments. It is the risk of losing money because of a movement in the exchange rate. For example, if the U.S. dollar becomes less valuable relative to the Canadian dollar, your U.S. stocks will be worthless in Canadian dollars.

2. Liquidity Risk

This is the risk of being unable to sell your investment at a fair price and get your money out when you want to. To sell the investment quickly, you may have to accept a lower price. In some cases, such as exempt market investments, it may not be possible to sell the investment at all.

3. Concentration Risk

This is the risk of loss due to your money being concentrated in a particular type of investment. You can mitigate this risk by diversifying. 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. Credit risk applies to debt investments such as bonds. You can evaluate credit risk by looking at the credit rating of the bond. For example, long-term Canadian government bonds have a credit rating of AAA, which indicates the lowest possible credit risk.

5. Inflation Risk

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, meaning the same amount of money will buy fewer goods and services once inflation kicks in.

Inflation risk is particularly relevant if you own cash or debt investments like bonds. Shares offer some protection against inflation because most companies can increase the prices they charge to their customers. Share prices should, therefore, rise in line with inflation. Real estate also offers some protection because landlords can increase rents over time.

6. Horizon Risk

The risk that your investment horizon may be shortened because of an unforeseen event, for example, the loss of your job. 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 lose money.

7. Longevity Risk

The risk of outliving your savings—is especially relevant for those already retired or nearing retirement.

8. Foreign Investment Risk

The risk of loss when investing in foreign countries. When you buy foreign investments, for example, the shares of companies in emerging markets, you face risks that do not exist in Canada, for example, the risk of nationalization.

9. Call Risk

This is a risk for bond issues and refers to the possibility of debt security being called before maturity. This typically takes place when interest rates are dropping.

10. Social / Political Risk

The risk associated with the possibility of nationalization, unfavorable government action, or social changes resulting in a loss of value is called social or political risk.

These are just a sample of the many different types of investment risks that can arise. You can experience one or multiple types at any time! Clearly, investing can be complicated. That’s why I implore you to hire a CERTIFIED FINANCIAL PLANNER™ professional. Making that choice could help make your life financially simple.

RELATED ARTICLE: Investment Basics Part II – Risk Tolerance & Investment Horizons

Speak with your financial advisor to determine which of these risks you’re susceptible to and how to mitigate them. Or, f you don’t have an advisor, reach out to us!