Of Investment Risks and Returns

Understanding Risks

There is no such thing as risk-free living. Everything you do involves some degree of risk. There’s a chance that you might slip in the bathroom floor when you take a shower or you might get into a car crash on the way to the office. You could get food poisoning from buying a hotdog from your favorite hotdog stand or get hit by lightning in the open field. All these are risks that come with daily living.

However, this does not mean that you should just hide in your room and not move for fear that these things can happen to you. Such an attitude would defeat the purpose of living. And while we can never completely take out risks from our lives, there are ways to minimize our exposure to them. You can install handrails in the bathroom or non-slip mats, for example. By wearing seatbelts or not driving when you have just indulged, you become aware of the movement of other cars on the road and can react accordingly.

The same holds true with investments. It always involves taking risks. If you shy away from stocks or other volatile investments and stick with traditional savings accounts, you might end up with very minimal returns that won’t be enough to fund your existing lifestyle when you retire. Also, if you stay on the perceived side of safe investments, you risk having inflation and taxes devalue your investment.

To further understand what risks are, here are the various kinds of risks that you will be facing when you invest:

Market Value Risk. This happens when the market plunges such as when socio-political events threaten investors and they pull out their investments or when a new investment craze comes in and everyone seems to be heading in that direction, ignoring the companies that had been performing quite decently. What you must understand as an investor is that the market has its ups and downs which can happen in a very short span of time. In 2000 to 2002 stocks dropped to 39 percent; in 2007 to 2009, it fell 55 percent. But the worst fall happened from 1929 to 1932 when the stock market fell 89 percent.

However, it would be erroneous to think that you should shy away from stocks. If there is anything that the market has proven all these years, it’s the fact that it will always rebound. Furthermore, the concept of market value risk makes diversifying your investments very important. You should not put all your eggs in one basket, so to speak. By buying shares of stocks in companies that are performing well in different economic conditions you reduce the risk of losing all your investments when the market underperforms.

Individual Investment Risk. Your profile as an investor is also another type of risk. If you are still young and are still starting to accumulate assets as you work your first job then you can generally invest in more volatile kinds of investment vehicles like stocks. In case they don’t do well, you still have a lot of time to recoup your investments. It would not be wise to put most of your money in riskier investment vehicles if you are already nearing retirement. In case the company stock loses value, you’d be hard-pressed to recover.

The level of knowledge you have regarding your investments can itself be considered a risk. If you don’t study the stocks that you are going to purchase beforehand, you are likely going to end up losing a lot of money. While no one can accurately predict what will happen in the future, being an informed investor reduces the risk that you will invest in the wrong stocks.

Inflation Risk. Inflation refers to the sustained increase in the price of goods and services. When there is inflation, the purchasing power of the dollar is lessened. When there is inflation, the value of your investments also depreciates. When you put your money only in investments that are perceived to be safe such as savings accounts, there is a very big chance that the rate of inflation can take over the value of your investments. By investing in stocks, you generally protect yourself against inflation since companies can adjust their prices to coincide with the rate of inflation. This explains why even retirees are advised to put some of their investments in stocks.

Career Risk. Where you choose to work and the direction you are taking with your career can affect the investments you take. If you decide to break away from the security of formal employment so you can start your own business that can be a risky venture on your part. This risk, however, can be managed if you do the necessary studies about your business first and having back up funds in place while you’re still making it grow before plunging in right away.

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