Types of Risk

Types of RiskWhen most people think of investment risk, they think of falling stock or bond market values. But "market risk" is just one of several sources of investment risk. A number of risks, such as the following, can affect an investment's value.

  • Market risk—how much the general trend of the market up or down affects the investment's value.
  • Interest rate risk—the impact of interest rate changes. Interest rate changes can affect not only "cash equivalent" savings/investment vehicles such as passbook accounts or CDs but they can also affect the value of bonds. If you purchase a 5-year bond one day at 7%, for example, and the next day the interest offered on similar bonds goes up to 7.5%, then your bond is worth less on the market if you wish to trade it (rather than hold it to maturity). The rise and fall of interest rates also indirectly affect the stock market.
  • Inflation risk—the impact of rising prices can erode the buying power of the money. For example, if a CD is earning 1.7% annually but inflation is running at 2% annually (its recent level), then even though the nominal dollar value of the CD is increasing, the purchasing power represented by those dollars is actually declining because the interest earned is not keeping pace with or exceeding inflation.
  • Credit risk—the potential for default or nonpayment on investments offering fixed income. For example, one of the reasons that junk corporate bonds are considered high risk investments is their credit risk.
  • Liquidity risk—the possibility that the investment can not be sold as quickly as desired causing the asset to lose value. If you own real estate, for example, you may not be able to sell it as quickly as you like or at the price you desire, while expenses still continue.
  • Business risk—the possibility that a company you've invested in will not do well.

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