12 Investment Risks in Simple Terms
There are always risks when investing. When you understand the risks and determine what investments mitigate those risks, you will be in better shape to make more informed decisions. Let's break down these investment risks into more relatable terms:
Business Risk (Risks Inside a Company):
This is like a restaurant facing problems like bad chefs or fewer customers. In investing, it's the risk that the company you invest in will face internal problems (bad management, poor product, etc.) that can reduce its profits and your investment.
Currency Risk (Risks Due to Exchange Rates):
Imagine you buy something from another country, but when it's time to pay, the exchange rate changes and it suddenly costs more in your currency. This is a risk when you invest in foreign currencies or in companies that do a lot of business in other currencies.
Credit Risk (Risk of Not Getting Paid Back):
It's like lending money to a friend who might not pay you back. In investing, it's the risk that a company or government you lend money to (by buying their bonds) won't be able to pay you back.
Inflation Risk / Purchasing Power Risk (Money Losing Value):
Think of your money as a melting ice cube. Over time, inflation (increase in prices) can make the purchasing power of your money decrease. So, your investments need to grow at least as fast as inflation to maintain their value.
Liquidity Risk (Hard to Sell):
Imagine owning a big piece of furniture that’s hard to sell quickly. Liquidity risk is when you own an investment that you can't sell fast or without losing value, like real estate or certain stocks.
Political Risk (Risks Due to Political Changes):
This is like your neighborhood rules suddenly changing, affecting your daily life. In investing, it's the risk that political upheaval or changes in government policy will affect the value of your investments, especially in unstable countries.
Concentration Risk (All Eggs in One Basket):
If you put all your money in one type of investment, it's like betting everything on one horse. If that investment fails, you could lose a lot. Diversifying reduces this risk.
Reinvestment Risk (Risk of Lower Returns on Reinvestment):
Say you invest in a bond, and when it matures, interest rates are lower, so you can only reinvest at a lower rate. This risk is about not being able to reinvest money at the same or higher rate of return.
Country Risk (Risks of Investing in a Specific Country):
This is like your favorite store being in a neighborhood that's suddenly becoming unsafe. Country risk involves changes in a country's situation (like economic instability or war) that could affect all investments in that country.
Alternative Risk (Risks in Alternative Investments):
These are like exotic, unusual food dishes – they might be great, but there's a higher risk because they're unfamiliar. Alternative investments like hedge funds or commodities are less traditional and often riskier.
Foreign Investment Risk (Investing in Other Countries):
This is like playing a board game with different rules. Investing in foreign countries can be risky because you're dealing with different economies, political climates, and even currency fluctuations. It can offer high rewards, but it's more unpredictable.
Longevity Risk (Risk of Outliving Your Money):
Imagine planning a long trip but not packing enough food. Longevity risk is the risk that you'll live longer than expected and your retirement savings won't be enough to support you in your later years.
Understanding these risks helps you make more informed decisions about where and how to invest your money, aiming to balance the potential rewards with the risks you're comfortable taking.
