Having an expert guide you can help to align your investment portfolio to your financial goals, but it’s equally as important to understand investment risk and how it can affect you.
What is investment risk?
Risk exists in many parts of our lives, from crossing a busy road to buying a house, but not all risk is so obvious. When it comes to making important financial decisions about investing your money, understanding how investment risk impacts you is crucial.
Simply put, investment risk describes the uncertainty of the returns on your investment. It looks at the possibility of losing and making money when you invest. How your portfolio is built, its risk level and other, key investment decisions are mainly shaped by three important factors:
- your appetite for risk: how you view risk and how you would feel about different
levels of potential losses;
- your investment objectives: what you need, or require your investment returns to be over the appropriate time horizon (the period of time you hold the investment for);
- your capacity for loss: the extent to which you can absorb a fall in the value of your assets without it having a negative effect on your lifestyle.
Types of investment risk
There are several types of investment risks that could affect your portfolio, depending on how it is constructed. A wide range of asset classes can make up a portfolio, including cash, property, equities and fixed-interest securities to name a few – all of which carry some level of risk. Some of the types of investment risk that could affect you include:
- Market risk – arises from financial market fluctuations
- Interest rate risk – arises from changing interest rates or the frequency at which rates change
- Exchange rate risk – arises from the change in the value of one currency against another
- Business risk – arises from the possibility that a company will have lower than expected profits, or it’ll experience a loss rather than a profit
- Inflation risk – arises from uncertainty over the future real value (after inflation), of your investment
- Liquidity risk – arises when assets cannot be traded quickly enough to avoid a loss or, in some cases, lock in a gain.
Investment risk management
It is impossible to completely remove investment risk, but financial experts can help to manage the risk. One of the main ways this is done is through diversification – investing in different asset classes that all don’t behave in the same way during different economic cycles, in order to create a balanced portfolio.
Other factors that can be used to manage investment risk include investing with a long- term view or investing to beat inflation which, based on your individual circumstances and appetite for risk, a financial adviser can help to explain.