I Don't Want A Lot of Risk

“I don’t want a lot of risk”. I hear this often when talking with people about investments and their portfolios. You have probably heard this as well…in fact, at some point, you have probably felt or expressed this too! But, have you ever thought about what is ‘risk’?

Typically, the above statement means something to the effect of not wanting to lose money. I think we all get that point. However, are you familiar with all of the different types of risk that could cause an investment to go down? Let’s review some…

• Market risk: The risk of investments declining in value because of economic developments or other events that affect the entire market.
• Equity risk: The risk of a drop in the market price of shares.
• Interest rate risk: The risk of a change in interest rates. For example, if the interest rate goes up, the market value of bonds will drop.
• Currency risk: The risk of movement in the exchange rate. For example, if the U.S. dollar becomes less valuable relative to the Canadian dollar, your U.S. stocks will be worth less in Canadian dollars.
• Liquidity risk: The risk of being unable to sell your investment at a fair price and get your money out when you want to.
• Concentration risk: The risk that your money is concentrated in 1 investment or type of investment.
• Credit (default) risk: The risk that the government entity or company that issued the bond will run into financial difficulties and won’t be able to pay the interest or repay the principal at maturity.
• Reinvestment risk: The risk from reinvesting principal or income at a lower interest rate than you were previously earning.
• Inflation risk: The risk losing purchasing power because the value of your investments does not keep up with inflation and the same amount of money will buy fewer goods and services.
• Horizon risk: The risk that your investment horizon may be shortened because of an unforeseen event, for example, the loss of your job, and force you to sell investments that you were expecting to hold for the long term.
• Longevity risk: The risk of outliving your savings.
• Foreign investment risk: The risk of loss when investing in foreign countries.
• Political/Regulatory risk: The risk new rules or laws to govern an industry or sector that hurts your investment.
• Volatility risk: The range which the value of an asset moves up and down. Low volatility usually seems more attractive, but higher volatility typically delivers superior returns to compensate.
• Tax risk: The risk of taxes eroding your returns.

While there are additional types of risks beyond the above list, the takeaways are 1) All investing incurs some level of risk; 2) by avoiding one type, generally another type of risk is then included; 3) there are a lot of variables to consider when investing money; and 4) for investments to grow (which usually ties in to achieving financial goals), a certain level of risk is necessary to have the potential to get the desired returns. However, based on your age, financial goals, etc. we can choose your level of risk and what type of risk is best to take given your situation. I’m not trying to cause concern or encourage you to put all of your money in cash (which would bring about another type of risk, namely inflation risk). Rather, my hope is that you understand that there is no “silver-bullet” or simply one investment that will eliminate risk. This is why I recommend various types of investments for your portfolio to diversify the risks in an effort to generate the desired returns.