It is important for investors to understand that every investment has its own set of risks. One key to successful investing is to recognize the different types of risks that could be a threat to one’s financial well-being and to take steps to minimize their impact. What follows is an overview of the primary forms of investment risk as well as some tips on how to minimize that risk.
Market Risk
This is the risk that the prices of securities may fall due to external factors such as world events, economic changes, or investors’ expectations and outlook. Stock investors are more likely to be impacted by this form of risk than fixed-income investors.
Inflation Risk
Also known as purchasing power risk, this is the risk that is connected to the uncertainty over the future purchasing power of the income and principal of an investment. When prices rise (inflation), purchasing power typically falls. Historically, stocks have been less impacted by this type of risk since they have been able to appreciate in price at a faster rate than the rate of inflation. Typically, lower yielding cash equivalents are more likely to be affected by a rise in inflation.
Interest Rate Risk
When interest rates move up and down, bond prices change. When interest rates move up, newly issued bonds will generally pay a higher interest rate than similar, older bonds. What happens next is that the market of existing bonds falls because there is less demand for them. In other words, they lose market value. The opposite happens when interest rates fall: Older, previously issued bonds will pay higher rates of interest than newly issued bonds, making the older bonds more appealing to investors. The bottom line is that falling interest rates are generally beneficial to bond owners.
Maturity Risk
Since it is impossible to predict how the financial markets will perform in the future, long-term bonds are generally considered to be riskier investments than short-term bonds. This type of risk is known as maturity risk. Issuers of long-term bonds attempt to compensate for the additional risk by offering higher yields.
Credit Risk
Credit risk is the risk that a bond issuer will be unable to pay interest on the bonds it issued or repay principal when the bonds mature. Rating services, such as Moody’s Investor Services and Standard & Poor’s, carefully investigate the financial health of a bond issuer in order to alert investors to the risks of a particular issue. The rating services rate municipal bonds, corporate bonds, and international bonds. They do not rate Treasury bonds since the assumption is that they are solid, backed by the full faith and credit of the federal government. The rating services rate bond quality according to a system that employs letters and numbers, with AAA or aaa indicating the highest quality issues and CCC or ccc and below indicating poor quality issues that could default.
Credit ratings influence the interest rate an issuer must pay in order to sell its bonds. However, credit ratings are opinions about credit risk. Even though credit ratings are forward looking in that they assess the impact of foreseeable future events and can be useful to investors, they are not a guarantee that an investment will pay out or that an issuer will not default.
Currency Risk
Changes in currency exchange rates will have an impact on returns from overseas investments. For example, when the dollar rises in value in relation to the Euro, the return on a fund that holds a large number of stocks in European businesses is reduced when the Euros are converted to U.S. dollars. The opposite occurs when the dollar falls in value in relation to the Euro.
All investments have risks. Before buying a security, understand that the key to investing success is balancing risk. You can do this by having a well-diversified portfolio and an asset allocation strategy based on your risk tolerance and the number of years until you retire.
Diversification helps you manage risk by spreading your assets among a broad mix of different investments. When you do this, you are taking advantage of the fact that securities usually don’t move in the same direction at the same time. When some investments drop in value, others may rise or remain unchanged, offsetting to some degree those investments that lose value. Of course, diversification does not ensure a profit or protect against loss in a declining market.
Be sure to talk to your financial professional for insights on how you can balance risk in your investment portfolio.
Once you have an idea, starting a business can be very exciting, but also daunting. It is important to map everything out before you start to avoid potential pitfalls down the road. Here is a guide to set up your new business for financial success.
Once a retirement savings plan has been approved and is in place, it’s tempting to sit back and adopt an “I’m done,” hands-off attitude. However, to ensure that a plan will continue to operate effectively, employers should periodically review plan provisions and features. Here are some points to check.
Like most successful people, you want to be certain that what you have spent a lifetime building will be passed on to your heirs in the manner you desire. Retaining an attorney to draft a will is a critical first step in achieving this goal. It’s equally important that you carefully select a personal representative (or executor) to carry out the instructions in your will.
Taxes are an integral part of running a business, and they often represent a substantial portion of your expenses. However, there’s good news for businesses looking to reduce their tax burden and stimulate growth – business tax credits. These credits provide financial incentives for companies to invest in various activities, from research and development to promoting renewable energy. In this article, we’ll explore what business tax credits are, how they work, and how they can benefit your company.
Individual Retirement Accounts (IRAs) are designed to help you save for retirement, and they come with a set of rules and regulations to encourage long-term savings. While it’s generally not recommended to dip into your IRA before retirement, there are certain circumstances where you can borrow from your IRA without incurring penalties or taxes. However, it’s crucial to understand the rules and potential consequences of doing so. In this article, we’ll explore the rules for borrowing from your IRA.