Every investment whether its equity, debt, gold or real estate, has risk associated with it. These risk define the level of volatility you will experience while your money is invested. The approach should be to identify these investment risks before you take any investment decisions and analyze how it will affect your portfolio. While the impact of some of the risk can be reduced through strategies like diversification some risks are beyond investors control . Its wiser to aware yourself from all such risks so that appropriate actions can be taken when market movements deviate your investment objectives.
Let see the various types of risk inherent to different investment avenues:
1. Market Risk– There are factors like economic conditions etc. which impact the markets but are beyond any investor’s control. In such scenarios the impact on the different securities is almost similar and so there is not much you can do. The market risk produces higher volatility and so one should be well aware while investing in any market link instruments. This will avoid situations like panic selling whenever you will experience such volatility in your investments.
2. Liquidity Risk– It arises when there is less possibility of buying or selling any investment as you desire or within a certain time frame. Real Estate are very much prone to these kind of risk and so you should take this into consideration while you are aiming for higher accumulation of such assets.
3. Inflation Risk– Inflation reduces the purchasing power in the future and so any investment which is not appreciating more than inflation will fall short of meeting the objective. So its important to assess the probability of appreciation from the asset during your selection process.
4. Taxability Risk– Along with inflation tax is the second devil which eats out returns especially in fixed income instruments. It gives a double blow when the taxability is higher on any investment which does not have probability of producing higher returns. hence, you should clearly evaluate the tax structure of the gain to select the appropriate instruments.
5. Interest Rate risk– This denotes a risk where fixed income investments decline in their value whenever there is an increasing interest rate scenario. Debt Mutual funds are mostly impacted by these and if the situation is prolonged even the equity market gets impacted.
6. Reinvestment Risk– It is a risk where the maturing investment is not able to fetch the same or higher returns than the previous one. In such scenarios you are forced to take higher market risk or buy securities which have lower credit ratings to earn similar returns.
7. Credit Risk– A credit risk is one where the company issuing the debt security can default on the payments to the investors. Since securities are rated by different agencies, the low rated will have a higher default risk while the highest rated securities are considered to be low on credit risk.
8. Currency/Exchange Risk– A currency risk arises when investment in one currency has to be changed to other currency. Any fluctuation in one will impact the value of investment. The fall of rupee against dollar is a classic example of currency risk which benefited one set of investors while it was a highly disadvantageous situation for the other.
There can be some specific risk associated with a particular investment such as business risk of any sector which will impact your investments if the weightage is higher.
Thus, there are various kind of risk which have a capability of making your portfolio volatile. While creating an investment portfolio you should evaluate these risk and then match with your risk tolerance to know what you need to monitor to get the desired result.