You don’t get to the top without risk and with any investment, there is always risk. Each type of investment exposes you to different liabilities. So what’s the best way how to handle investment risks? And if you need guidance, where to get investment advice?
Everyone has a different tolerance to risk, so what works for others may not be suitable for you. The single most important thing to remember is that you don’t gamble what you can’t afford to lose. You can expose yourself to a lot of risk, or make a decision to be conservative and make low risk investments. The choice is yours.
There are eight types of common investment risks to consider and weigh up which is acceptable to you.
1. All-Your-Eggs-In-One-Basket Risk
Otherwise called concentration risk, this is when all your funds are invested into one specific share, type of investment, or one industry. If for some reason the bottom falls out of that market or type of investment, you risk losing the lot. To avoid this, diversify. Spread your risk over different geographic locations, industries, and types of investments. For instance if you have invested in the steel industry, consider also investing in the tech market.
2. Bad Credit Risk
It’s not just individuals that have bad credit. Companies and even the Government can have financial difficulties that affect their credit rating. If for some reason they get into financial difficulty, they may not be able to pay interest, or even repay the principal. Investment companies have credit ratings, so research into firms and choose reputable firms with good ratings- AAA is the lowest risk.
3. Foreign Investment Risk
This is the risk when you’re investing in the unknown. Depending on the country, the government can interfere with companies, changing tax rules or other practices that will affect the running of the business. The development of wars or civil unrest is also a possibility in many countries, which would have implications for your investments. To avoid this, avoid developing and emerging markets.
4. Horizon Risk
An investment horizon is the expected end date of your investment, when it’s reached its peak and you’re ready to sell. Horizon risk is when there is a change of plans, perhaps due to the economy or family circumstances, and you have to sell before the planned date. You may end up selling before the investment has matured, or in a low market.
5. Inflation Risk
In New Zealand, inflation has averaged around 2.7% since 2000. In the early 1980’s however, it swooped close to 20%. NZ is a cork bobbing on the ocean of the world markets, and we are affected by other heavyweight markets around the world. Inflation risk is when inflation rates outstrips the value of your investments. While you can’t control inflation, you can invest in things less likely to suffer if the inflation rate increases. For example, with property investments you can increase rent to cover inflation.
6. Liquidity Risk
When you sell your investment, you want to make money on it, or at the very least, recoup your initial investment. Liquidity risk is when the investment cannot be sold for a profit, meaning you either accept a lower price or run the risk of not being able to sell the investment at all. To avoid this, do your research beforehand and also know when the exit the market.
7. Market Risk
Probably the most common risk is that your investment declines in value due to current economic climate or other events. Equity riskrelates specifically to shares, and the drop in share price as a result of the drop in the market. Interest rate risk is when your debt investment loses money due to changes in the interest rate.Currency risk is when your foreign investment risks losses due to exchange rate. If you have to convert any profits from the foreign investment into NZD, the income you receive will be affected by the exchange rate.
8. Reinvestment Risk
If you sell your bonds at 5%, then interest rates fall, you’ll have to reinvest at the lower rate. This can be avoided by spending the interest payments or the principal when it matures.
How to Avoid Risking It All With Investments
There’s a simple five step process to avoid disaster.
- Don’t limit yourself to one country, brand, industry, or style of investment. If your investment is through a managed fund, what has that fund invested in on your behalf? Is it diversified?
- Don’t follow trends. Buy in gloom and sell in boom.
- Portion sizes matter. If you have a risky investment that could potentially create a lot of money- don’t risk it all. Only gamble what you are prepared to lose.
- Constantly assess the market. Don’t be scared to deviate from your plan if the market is favourable. If a share price has reached your upper limit now, sell and take the win.
- Set a stop point. Have a dollar value on the shares, or interest rate, or whatever it is the influences your outcome. If you have reached that point and can’t afford to wear greater losses, sell.
Where to Get Investment Advice?
A great adviser will know how to handle investment risks and get the best outcome for you. If you’re wanting professional help and wondering where to get investment advice, ask someone you trust who they recommend. Follow this up with your own research. A quick Google will show their qualifications and reviews. Make that phone call and find out what type of investment they specialise in. You also need to assess if you feel comfortable with them and if you feel like you are being understood.
Investing can be as risky or as safe as you want it to be. Listen to an expert, do your research, and enjoy the ride!