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Investment risks

Risk is one of the most overlooked and poorly understood areas of the investing process. When investing, people tend to focus on the potential gain rather than the potential loss they could experience. That’s why it is essential to consider all the downsides and different types of risk you may be exposed to with any investment opportunity. After reviewing this section be sure to explore the common investment scams and red flags to be aware of.

Common types of investment risk

Business risk

The risk associated with the unique circumstances of a particular company as they might affect the price of the company’s securities. It can be affected by a number of issues such as changes in share prices, employee layoffs, gains or losses of contracts and changes in management.

Market/systemic risk

The day-to-day fluctuation in a stock’s price (also known as volatility). Market risk applies mainly to stocks and options. In general, stocks tend to perform well during a bull market and poorly during a bear market.

Default risk

The risk that a company or individual will be unable to pay the contractual interest or principal on its debt obligations (bonds or debentures). Government bonds, especially those issued by the federal government, have the least amount of default risk and least amount of returns. Corporate bonds tend to have the highest amount of default risk, but also have higher interest rates.

Foreign exchange or currency risk

Currency exchange rates can change the price of an investment. Foreign exchange risk applies to all financial instruments that are in a currency other than your domestic currency. There is a possibility that a profit may be negated once a profit from a foreign investment is converted to domestic currency, especially if exchange rates have changed since the investment was made.

Inflation risk

The possibility that the value of assets or income will decrease as inflation shrinks the purchasing power of a currency. Inflation causes money to decrease in value over time, and does so whether the money is invested or not.

Interest rate risk

Investments such as bonds, Guaranteed Investment Certificates and mortgage-based investments will fluctuate in value when interest rates change. When interest rates go up, the value of fixed-rate investments drop. When interest rates go down, the value of fixed-rate investments increase.

Liquidity risk

The risk coming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss.To sell the investment, you may need to accept a lower price.

Mortgage risk

The risk that the individual or company that borrows the money will fail to make timely principal and interest payments in accordance with the terms of the mortgage.

Opportunity risk

The risk that a better opportunity may present itself after an irreversible decision has been made.

Political risk

Return on an investment could suffer as a result of instability or political changes in a country. For example, the action of the United Kingdom voting to withdraw from the European Union caused the British pound to drop in value.

Unsystematic risk

Sometimes referred to as “specific risk”. Unsystematic risk affects a very small number of assets. An example is news that affects a specific stock such as a sudden employee strike.

Want to learn more about investing and its risks?

If you would like to learn more about investing and the associated risks visit our resources section for useful fact sheets, videos, and tools as well as our Investing 101 classes that can help guide you in the right direction along your financial journey.