What is investment risk?

What is investment risk?

Investment risk is the probability of incurring a loss or making a gain as a result of an investment decision. Every investment involves uncertainty, and the return depends on the level of risk we are willing to take. For example, government bonds are considered to be the safest financial instruments, but at the same time, they usually provide little financial return.

Examples of investment risks

Here are some key examples of investment risks. Let’s take a look at them.

• Financial and business risk

Financial risk determines the likelihood of a situation in which an entrepreneur is unable to repay loans or other financial obligations. Business risk, on the other hand, is highly correlated with the former but relates to the inability to generate sufficient revenue to achieve strategic goals.

• Market risk

This is a situation where changes in market conditions can bring investment losses. These can include not only price fluctuations, inflation (reducing real profits and increasing the cost of living), and changes in exchange rates but also unforeseen situations like armed conflicts or epidemics.

• Macroeconomic risk

It may also be associated with market risk. It usually refers to events in the political context, the general economic situation in a country or region.

• Interest rate risk

A change in interest rates affects the value of financial instruments. For example, rising interest rates cause the price of bonds to fall.

• Liquidity risk

It involves the inability to monetize a financial instrument quickly (lack of a willing buyer or seller) and the risk of bankruptcy, which can result in the loss of much or all of your capital.

• Concentration risk

If you invest your capital in only one financial instrument, you risk losing the entire amount.

• Management risk

The ineffective strategy of the company whose shares you have purchased negatively affects their value.

• Risk of default

Refers to so-called debt instruments (e.g., bonds) in which one party to the transaction agrees to return the entrusted capital by paying interest on an issued security.

• Cash flow risk

Includes fluctuations in the value of cash flows associated with inflows, outflows, and flows of financial instruments.

How to manage investment risk?

It’s unlikely to eliminate the risk entirely, you can only reduce it to the minimum possible financial loss. How to manage investment risk?

• Start with virtual money – if you’re new to investing, it’s a great way to get started without putting any money down. The Stock Exchange offers a virtual stock market simulator with live quotes so you can learn without taking unnecessary risks,
• Diversify investment instruments – you can allocate your resources in various ways, for example, by investing in different types of financial instruments (stocks, bonds, certificates, precious metals, etc.), by investing in several different sectors of the economy (finance, healthcare, etc.), by entering foreign markets (for example, by investing your capital in real estate abroad), by buying shares in different companies,
• Average out costs – for some time, regularly invest a certain amount of money in stocks. A gradual investment will minimize a significant financial loss in the event of a decline,
• Set boundaries – it may seem trivial to control your emotions and set an amount you will not exceed when buying financial instruments. However, making investment decisions is highly dependent on your state of mind and the feelings that are driving you at the moment. In the case of the stock market, strong emotions are usually a bad advisor,
• Keep an eye on your financial situation – invest only the amount of money you are ready to lose. Don’t take out loans for investments, as you could be in serious financial trouble if you fail,
• Talk to an investment advisor – if you do not feel confident enough and you want to get the opinion of an experienced person in the field of investing, you can turn to an investment advisor who will match the appropriate strategy to your capabilities and expectations,
• Beware of investment scams – brokers do not always act according to the law. While promising high returns and profits, they may persuade you to invest in unprofitable products or services or phish for personal information. The risks can be many, so you must always carefully analyze any offers,
• Choose long-term investments – if security is important to you, choose long-term investments. Determine the maturity date of an instrument, as this will make it easier for you to make decisions later,
• Buy insurance – the market is dynamic, which can cause big changes and fluctuations in the stock market. However, you can hedge your fiat currency (paper money has poor purchasing power, especially in times of inflation), and you can buy gold or cryptocurrencies so that in case of loss, you will still receive at least a small return on your investment.

Summary

Uncertainty is an inherent part of investing and must be faced by all participants in the capital markets. One important aspect of this field is to have sufficient knowledge of possible investment risks in order to identify them effectively. The other important element is to manage your assets skillfully and to make sound decisions that will allow you to multiply your resources.

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