In finance, calculating risk is a straightforward equation, easy to understand if you know your arithmetic, but if you are a stock trader, there could be different types of risk that you need to take into consideration, and not all these risks could fit neatly into an equation. Read on to find out the type of risks you need to keep in mind when investing:
This is the most common type of risk investors face when buying stocks or bonds of any kind. Business risk refers to uncertainty regarding security. What if the company you bought shares from goes bankrupt and is no longer able to pay off bonds? This type of risk is inevitable whether an investor is trading stocks or buying bonds. Researching the company in advance and diversifying the overall investment portfolio are the best ways to reduce your exposure to business risk in investing.
Political or Social Risk
The market is not the only thing that introduces risk to your investment. Don’t forget the political or the social side of things. For example, it might seem like a really good idea to invest in marijuana penny stocks now, which have experienced an uptick thanks to decriminalization in several states, but a savvy investor won’t get too excited about cannabis because the legal pot movement is under threat by the Attorney General’s Department, headed by the staunchly anti-pot Jeff Sessions. If the current government pursues federal prosecution of weed even in legal states, the legal cannabis industry could come crashing to a halt. Cannabis is not the only sector to face this type of legislative risk. When investing in any sector or asset, understand how the law, public sentiment, or government regulation may affect it in the future.
Market risk or systematic risk is a term given to risk that can affect all types of securities at once. This means that having a diversified portfolio may not protect you from the risk. Market risk can occur because of an economic crisis, for example. Some investors try to protect currency assets against market risk by buying precious metals like gold, which are valued inversely proportional to fiat currency, however, that doesn’t mean you should rush ahead and buy gold. You should worry about market risk the most when investing in mutual funds.
Rising Interest Rates
If an investment has a fixed return rate, it’s naturally exposed to federal interest rate hikes. There are various factors that influence how the interest rate is raised or decreased. If it remains low, the returns would be high. Otherwise, it would not make investments in individual stocks or bonds particularly valuable. This is why investors are advised to look for signs when the interest rate could increase.
Currency Rate Fluctuations
The fluctuations of the exchange rate between various currencies can increase or decrease the value of assets purchased in that currency. American investors who own assets in dollars earn solid returns when the dollar is strong, but if the dollar is weakened for some reason, as it was during the 2008 crisis, the value of these assets will decline. The same is true of any fiat currency. To reduce your risk to the devaluation of any particular currency, you can own assets in multiple currencies. When investing, it’s important to keep the above types of risk in mind when purchasing or selling stocks. Some of these risks may affect certain stocks more than others, but systematic risk affects all. Take the necessary steps to reduce your portfolio’s vulnerability to any type of risk depending on the assets you own.