Risk is inevitable when investing. We all know this in theory, but in practice, there are ways to lessen the risks you face. Here are some of the most common risks investors face and how to avoid them.
1) Market Risks
Market risk refers to the overall market’s volatility. If the market rises, you could potentially earn a high return, but if it falls, your asset values can decrease significantly. You can protect yourself from this type of risk through diversification (not putting all your eggs in one basket). In order to prevent this type of risk, it’s best to buy assets that are diverse (stocks, bonds, etc.), and not over-invest in one sector. Always listen to your broker’s advice because they can help you prevent market risks.
2) Risk From Fraud
This is a major risk when you invest in the stock market. There are different types of investment negligence and fraud issues that you should be aware of. Investment negligence is when your broker doesn’t put your money in a solid investment. Fraud issues are when someone purposely mismanages your money, resulting in a loss of wealth and opportunity. Frauds can include Ponzi schemes (where an individual or company pays investors returns from their own money or money paid by subsequent investors, rather than from profit earned through legitimate sources) and Pyramid Schemes (involving the exchange of money for the right to receive compensation for recruiting new participants into the scheme). To avoid these problems, you should diversify your investments, keep track of your gains/losses, and stay on top of the news.
3) Inflation Risks
Inflation risk refers to the loss of net worth due to inflation. Inflation occurs when the price of goods and services rises, therefore decreasing your buying power. To decrease this risk, you should invest in inflation-resistant securities (i.e. commodities) and diversify your portfolio so that the majority of your investments are not in one asset class or industry.
4) Liquidity Risks
Liquidity risk refers to the difficulty of converting an asset into cash easily. It’s best to choose investments that are highly liquid, meaning a buyer or seller can convert an investment quickly and without a great loss in value. These types of investments include cash, money market instruments, treasury bills, certificates of deposit (CDs), Banker’s Acceptances, etc.
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5) Interest Rate Risks
These risks refer to the fluctuations in the value of an investment due to changes in interest rates. Sometimes, interest rates will fall and other times they may rise. When interest rates fall, the value of a bond goes up because its coupon (interest payment) is now more valuable. But if interest rates rise, the price of your bond will go down because it becomes less attractive to investors as new bonds become available with higher coupons (higher interest payments). This type of risk can be minimized by investing in fixed income securities, instead of variable or floating rate ones.
6) Political Risks
Political risks are the uncertainties of what your government may do to affect your investments. If you’re investing in countries with unstable governments, political risk can be an issue. These countries include those with a dictatorship, revolution, or civil war. A good example of this is when there is civil unrest or war in a country. To avoid this type of risk, invest in securities that are not correlated to events in any given country.
7) Timing Risks
Finally, timing risks refer to the risk that an investment’s value will not increase in a timely manner. Timing factors into your investment decisions, for example, when you should sell certain investments and when you should buy them. This type of risk can be minimized by diversifying your portfolio so that if one security goes down, another may rise. Also, stay informed of current events so that you can invest accordingly. For example, if a recession occurs, you may want to sell certain individuals and buy others.
When investing, it’s inevitable that you’ll take a risk. However, there are ways to minimize the risks you face and achieve your goals with less stress. This article outlines some of the most common risks investors may come across and how to avoid them. For example, if you diversify your investments, keep track of gains/losses, or stay on top of current events in order to make informed decisions about when you should sell certain securities and buy others as they become available-you can greatly reduce these types of risks from impacting your investment strategy. We hope this article was informative and helpful to you.