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Types of Risk

Interest rate risk

The holder of any debt is subject to interest rate risk. Which is the risk of owning a security, such as a bond, paying an interest rate that over time becomes lower than the current interest. Meaning you are now earning less than someone who bought a similar bond today. That is interest rate risk. And in this example of a bond equates to price risk. If you sold the bond that now pays less interest than a newly issued bond today, you will not be paid face value for the bond. You would receive a price less than face value to adjust for the lower interest rate receive.

Risk of loss of Principal

The most basic of all risks. Your initial investment is worth less today than the original purchase price.

Market Risk

The risk of losses in an investment due to movements in the market prices. The risk of loss of principal, your initial investment.

Price Risk

As discussed in interest rate and market risk, the example of a bond selling for less than face value since it pays an interest rate less than the current interest rates paid on the same bond if purchase today.

Diversification Risk

As discussed in interest rate and market risk, the example of a bond selling for less than face value since it pays an interest rate less than the current interest rates paid on the same bond if purchase today.

Inflation Risk

For instance, the risk of the value of a dollar not being able to purchase as much as a year ago. Where the costs of goods increase over time, such as the cost of eggs and milk are much higher than 20 years ago. In the case of investments, you can incur the risk of your earnings or price appreciation not keeping up with the increase in the costs of most other consumer products in comparison.

Credit Risk

When investing in corporate or municipal bonds, the borrower or the issuer of the bond has a credit rating just as you do when you borrow money to purchase a car or a house. Your credit rating determines the interest rate you will pay. The better your credit rating the lower you interest rate. The same exists for Corporations or Municipalities that issue bonds. When you purchase a bond, at the time of purchase it has a designated credit rating. While holding the bond and the issuer suffers a financial setback that affects its credit rating and directly affects the value of your bond. The value can go down.

Risk of Dividend Cut

If you are depending on the dividends paid from the stocks in your portfolio. And one of the companies you own cut the dividend paid. This happens from time to time. Your income from the portfolio has decreased.

Risk of Default

If you are a bond holder, the issuer of the bond can default or go bankrupt. Defaults have occurred in municipal bonds too. Defaults are disastrous. You not only do not receive the interest due, but the value of your bonds drop as well. You must always be aware of the credit rating of the issuer and aware of any changes in the issuer’s credit rating. With that said, bond holders are in front of the line of creditors just behind the preferred stock holders but in front of commons stock holders.

Risk of Bankruptcy

Companies do go bankrupt. Enron, General Motors and Worldcom are a couple that occurred in the last twenty years. Many others as well. Shareholders lose most if not all of their principal investment in the company if there is a bankruptcy.

Liquidity risk

Liquidity risk is a financial risk that for a certain period of time at a given financial asset, security or commodity cannot be traded quickly enough in the market without impacting the market price. Another scenario is where there are no buyers of a security, or no bid for the security.

Currency Risk

The risk is that there may be an adverse movement in the exchange rate of the denomination currency in relation to the base currency you purchased your investments under. Your investment has price fluctuation and the underlying currency can fluctuate too.

Reinvestment Risk

Reinvestment risk is one of the main genres of financial risk. The term describes the risk that a particular investment might be canceled or stopped somehow, that one may have to find a new place to invest that money with the risk being that there might not be a similarly attractive investment available. This primarily occurs if bonds (which are portions of loans to entities) are paid back earlier than

Systemic Risk

In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system that can be contained therein without harming the entire system. It can be defined as “financial system instability, potentially catastrophic, caused or exacerbated by idiosyncratic events or conditions in financial intermediaries”. It refers to the risks imposed by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a cascading failure, which could potentially bankrupt or bring down the entire system or market. It is also sometimes erroneously referred to as “systematic risk”.

Market Timing Risk

Basically the risk of being wrong. Buying securities and the market goes down. Selling and the market goes up. Thus creating losses in either direction.

Geo-Political Risk

When investing internationally smaller countries have nationalized the assets of companies that have invested in their country. Basically the country steals the assets of companies that have invested in their country. More recently when a country is attacked such as we were on 9-11. The terrorist attack shut the markets down for two weeks and spiraled downward for two more years. Most recently the country of Saudi Arabia decides to increase oil production while there is a glut in the oil market to punish American companies for developing greater supplies in the pursuit of the U.S. gaining more energy independence.

Risk of Taxation

Simply depending on the type investment you own and the complexity of that investment, you may pay more income tax than another investment. With general securities you rarely run into the taxation risk. But in the 1980’s and 1990’s when tax sheltered limited partnerships were prevalent, unit holders would sometimes be liable for tax on phantom income. A tax due on income received on paper only.

Risk of divorce

Not really an investment risk, but equally if not more devastating. Splitting of assets is no fun, but it happens all the time.

Risk of dying too soon

Pretty much the reason for life insurance. During your working life you have not accumulated enough savings and investment. If you die too soon, before you have saved enough for retirement, your spouse may not be able to retire comfortably. Thus one of the needs for life insurance. To fully fund retirement for your spouse in the event you die too soon.

Risk of outliving your money

The fear of most all retirees. Did I really save enough? What happens to me if I spend it all before I die? That is one of the reasons we are here, to help you develop a plan. Annuities are one of the popular solutions used. This is a side note, some professionals in my circle have said the person who spends their last dime with their last dying breath wins.  

Oh, did we say there are many types of risk?

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