Types of Risk
Fear is just a symptom of ignorance. The more you know about investment risks, the less you’ll fear them.
- Market Risk: This is when stock or bond prices drop and you appear to lose money on your investment. However, most losses are sustained over the short term of a year or less. As long as you don’t sell, your investment will have the chance to recover from price declines and earn you a greater profit.
- Inflation Risk: The risk that the rising costs of inflation will outpace the growth of your investment over time.
- Company Risk: This is the risk that the individual company in which you invest will fail to perform as expected.
- Credit Risk: Specific to bonds, credit risk refers to the company or government’s inability to repay principal plus interest to the bondholder.
- Maturity Risk: Also specific to bonds, this is the risk that the value of a bond may change from the time it is issued to when it matures. The longer the period to maturity, the greater the potential for price fluctuation. That is why long-term bonds generally offer a higher interest rate–to compensate for this greater risk.
- Legislative Risk: Whatever laws the government passes today may be extinct tomorrow. For example, the long-term capital gains tax rate has been changed five times in the last 20 years. Currently, capital gains may be taxed at 5, 15, 25 or 28 percent or a combination of rates. These tax levels are known as long-term capital gains and apply to assets that you hold for at least 366 days (more than one year). The long-term capital gain tax generally is much lower than what you pay on your regular income. Factors such as tax deduction and deferral should never be your sole reason for selecting an investment. These perks are at the mercy of Congress.
- Global Risk: It’s always a bigger risk to invest overseas than at home. Then again, it’s generally more rewarding to vacation in Europe than lounging around in the backyard. Over 50% of the world’s capital market opportunities exist outside of the U.S., so a purely domestic strategy can severely limit your long-term earnings potential.
- Timing Risk: Timing risk works two ways. First, you run the risk of investing a large sum of money when share prices hit their peak. Second, there’s the risk that you’ll need to access your money to pay for retirement or college expenses during a temporary market setback–causing you to lose money on your investment.
- Longevity Risk: This is the risk that you’ll live longer than your income can support you.