At least 10 types of investment risk exist, and there's no way to eliminate all of them. Playing it safe can be risky too, however. So the question isn't whether to take a risk, but what kind to take.
Risk tolerance varies from person to person and can change over time with changes in your personal and financial circumstances. You need to assess your risk profile by evaluating whether you consider yourself to be conservative, moderate or aggressive in your approach to investing.
Types of investment risk
Of the many kinds of investment risk, most investors only worry about one: the risk of losing money. With all the media hype about financial markets and the ease of checking on your returns, it's easy to see why investors can become fixated on market swings.
Market risk.
Market risk is the risk of losing money when the financial markets go down. When investors think of losing money, they're thinking about volatility. Volatility can be especially uncomfortable when prices fall steeply or remain down for a long time.
There are 3 strategies for combatting market risk: diversification, asset allocation and rupee-cost averaging.
Inflation risk.
Inflation is a loss in the value of what a rupee will buy. And the fact that you can't see inflation eroding your principal makes it all the more dangerous.
For long-term goals such as retirement or your child's college education, your biggest risk may be inflation. If your money doesn't grow enough, you won t be able to stay ahead of inflation. If you are conservative and solely select investments whose primary objective is to preserve rather than grow capital, you are especially at risk.
The main strategy for combatting inflation risk is to include stocks in your portfolio, which means accepting some volatility. Growth and volatility go hand in hand, you can't have one without the other. Falling short of your target for a long-term goal can be worse than living through market ups and downs.
Financial professionals see risk differently
Mutual fund managers, on the other hand, look at risk more broadly. To them, risk is more about the factors that contribute to volatility, such as:
Business risk.
Anything that can harm a company's profitability, from poor management to obsolete products, can be called a business risk.
Credit risk.
When bond issuers fail to make their promised interest payments or don't repay principal when it comes due, investors are experiencing credit risk.
Interest rate risk.
Rising interest rates are bad news for fixed-income investments. Interest rate risk measures how sensitive an investment's price is to interest rate fluctuations.
Currency risk.
The possibility that international investments will suffer because the rupee (or dollar depending on the fund) gains strength against the currencies of other countries is known as currency risk.
Country risk
. Political instability, financial woes and other problems that weaken a country's economy can spell trouble for money managers who invest there.
Why do people take investment risks?
Often called the risk-return tradeoff, investors accept greater investment risk because they are seeking higher returns. If you wish to reduce risk, you must be willing to accept lower returns. You just can't get a high return from a low-risk investment.
How much risk can you accept?
The amount of investment risk you can tolerate is a personal matter. If investment risk worries won't let you get a good night's sleep, you may have taken on more risk than you can live with.
Your investment advisor can help you develop realistic expectations of risk-adjusted returns by discussing with you the risks and rewards of each of your investments while matching your goals and objectives with appropriate mutual funds.
Mutual funds can help you reduce risk
Mutual funds have experienced and skilled professionals who determine and monitor risks on an ongoing basis. In addition, various bodies evaluate mutual fund returns by the risks they carry.
Diversification is one of the risk-reducing strategies mentioned above. Mutual funds are an excellent way to diversify your portfolio. Each fund invests in more companies and industries than you could probably own by yourself. The fund managers carefully research the individual companies and industries before adding them to the fund's holdings.
source: Franklin Templeton
