Investment risk is the possibility of loss or meeting danger or it can be a deviation from an expected return. Risk is associated with the performance, they can’t be separated. Understanding and managing risk is the most important part of investment decision.
There are four major types of investment risk. They are: market risk or volatility risk, inflation risk, interest rates, and performance. How to recognize these risks and the strategies for dealing them are explained below.
Market risk is generally termed as systematic risk. It is the risk which you cannot completely avoid and you must assume this risk if you invest. It relates to the factors that affect the overall economy or securities market. Market risk is also called as volatility risk which describes about the up and down movements in the price of an investment. Diversification is the best strategy for managing this risk. It acts as hedge against risk of market fluctuations.
Inflation risk is related to the purchasing power. As purchasing power increases inflation increases. The increase in rate of inflation decreases the value of your portfolio. Thus, the investment management strategy must weigh the risk of inflation against the risk of individual investments.
Interest rates are related to the fixed-income investments. An upward movement in the interest rates results in decrease in the value of fixed-income securities. Conversely, if the interest rates are low, the price of fixed income securities rise. This risk can be balanced by adjusting the term of fixed-income investments.
Performance relates to the gain or loss of your returns from investment. This is the major risk most people associate with while investing. Diversification is the best strategy to minimize this risk