All investments have risks associated with them.
For example, investors in equities run the risk that the market as a whole could decline, dragging otherwise healthy stocks with it. Bond investors could see their income get chipped away by rising inflation. Both types of investors could experience a changing legal and regulatory requirement that could detrimentally impact their portfolio. Many times an investor will assume one type of risk in the effort of avoiding another. For instance, an investor may have fled the volatile market for the safety of fixed income, only to be left on the sidelines should the market experience a significant rebound.
While risk is unavoidable, it can be managed. Diversification is one powerful tool in managing risk in a portfolio; a balanced portfolio distributes the various types of risk over a basket of securities. Maintaining a relationship with a knowledgeable Advisor is another way to lessen the impact of risk; your Advisor can help you in the security selection process, and will help you monitor your portfolio’s performance.
The following list highlights various types of risk:
- Capital Risk: the risk that the investor will not fully recover his/her entire investment. Options and other speculative investments have a high degree of this type of risk, while quality short-term investments such as Treasury bills enjoy minimal capital risk.
- Selection Risk: put simply, the risk of choosing a security that will perform worse than other available securities.
- Timing Risk: the risk of buying or selling at an inopportune time, thus limiting profit or incurring a loss.
- Legislative Risk: the risk that future legislation will impact today’s investment decisions. Federal, state and local laws or regulations may change without notice, possibly impacting a security’s performance.
- Liquidity Risk: the risk that, should the quality or desire of a particular investment decrease, the holder will have a difficult time selling.
- Market Risk: the risk that the value of a security will decline due to overall market conditions, not by any fault of the issuing company.
- Credit Risk: the risk that the issuer may become unable to pay interest and/or principal when due on fixed income securities. U.S. Government securities are the least likely to default on payments, while "junk" bonds have a high degree of credit risk.
- Inflationary Risk: the risk that inflation will reduce the purchasing power of a dollar over time. Equity securities tend to provide the best protection against this type of risk, while bonds are more susceptible due to their fixed income and possible long-term exposure to rises in inflation.
- Interest Rate Risk: the risk that, as interest rates rise, a bond investor’s holdings will decline as more attractive offerings enter the market. The longer the maturity on the bond, the greater the risk. Some stocks are susceptible to this type of risk as well (companies that borrow for financing operations will see less profit should the cost of borrowing increase; this will decrease their stock price).
- Reinvestment Risk: the risk that a bondholder will be unable to reinvest interest payments at a rate equaling the yield-to-maturity. Zero-coupon bonds do not have this type of risk.
- Call Risk: the risk that a bondholder will have their bonds called away by the issuer if the prevailing interest rates decrease below what their bond is paying. The bondholder would then have to invest in bonds that do not pay as much interest.
Your Investment Center representative can work with you to determine how much risk your financial situation and goals can tolerate.