Fact: There is no such thing as an entirely risk-free investment.
Even securities that are sold and guaranteed by the government are not exempted from risk. Investment Risk comes in different flavors, but it is normally associated with volatility — or the tendency of an investment to rise and fall in value.
Learning about risks and understanding what they are should come first before you start making any kind investment move. Below is a list of some of the most common types of risk you will come across with in your journey as an investor.
1. Inflation Risk
I’m not really so fond of quoting Robert Kiyosaki, but if you happen to read some of his books, you should have remembered that he blatantly declared this statement over and over: “Savers are losers!”
Well, he was referring to that dirty word in investment that starts with letter I – and you get it: Inflation.
In layman’s term, inflation refers to the tendency of prices of commodities to go up in values. That is, inflation is the increase in the cost of living.
When it comes to your investment money, if it is not earning enough, it will eventually have a reduced purchasing power as a result of inflation.
2. Tax Risk
The famous Albert Einstein has placed Income Tax as “the hardest thing in the world to understand.” Of course there are many kinds of taxes in the Philippines, among them are the following:
- estate tax
- real property tax
- capital gains tax
- documentary stamp tax
Your investment — real estate, stocks, bonds, time deposit, savings account, whatever it is — will always be subject to taxation in one form or another.
3. Credit and Default Risk
Investopedia defines it as “the risk of loss of principal or loss of a financial reward stemming from a borrower’s failure to repay a loan or otherwise meet a contractual obligation.” In worst case scenario, it will eventually result to default.
4. Interest Rate Risk
This one is not very obvious and in fact appears to be illogical. But here is the cardinal rule every Bond investor should know: Interest rates have an inverse relationship with the Bond Prices. When interest rates rise, bond prices move down — and vice-versa.
I guess I will have to explain it in more detail in another article. Meanwhile, just bear in mind that this type of risk affects more those who are holders of long term bonds than those of short-term bonds.
( See also: A Closer Look at Bonds. )
5. Company Risk
Holding securities (bonds or stocks) in only one company exposes the investor to the risk of that particular company. What if it goes under and can’t pay its obligations? What if their newly released product turns out to be a market disaster with only a handful of buyers?
The most obvious way of mitigating this type of risk is to spread your holdings to different companies.
6. Sector Risk
You can think of sectors as categories of industries that collectively make up the financial market. There are so many sectors out there. Some examples:
- Banking
- Mining and Oil
- Real Estate
- Financial
- Industrial
- Technology
Each of these represents some form of risk that affects its own class or industry. The Dot-Com Crash in the US, for example, beset the Technology Sector some time in the year 2000.
7. Liquidity Risk
Liquidity refers to the convertibility of an asset into cash. It answers the question: “How soon can you get your investment in the form of cash?”
Cash is always the King because it is widely accepted as a medium of exchange. And that is why liquidity is one of the most important features you should look for in an investment vehicle.
Here are some investments which are not very liquid:
- Real Estate (house, land, building)
- Limited Partnership
- Private Equities
Another way of thinking about liquidity is to answer the question: “How soon can you find a buyer when you sell your investment?” Liquid means there is a ready buyer.
8. Event Risk
Don’t forget that in anything that you do, Murphy’s Law is always at work and is just lurking in the background. Oftentimes, these are outside of the company’s control.
Some unpleasant, undesirable and unexpected event could happen anytime that could cause the decline of an investment’s value.
Here are some examples:
- Earthquakes, tsunami and other natural disasters.
- Changes in the economic outlook of the US – the biggest economy to date.
- The untimely death of a good president.
These are rare events but they could somehow contribute to the value of an investment.
9. Currency or Exchange Rate Risk
There was once a time in the Philippines when those who don’t have US Dollars abhor those who are earning in dollars (or recipient of US Dollars) who don’t covert them to the Philippine Peso – our beloved national currency. That kind of practice is called Dollar Hoarding and those who do it hope to eventually cash out at some later time when the dollar appreciates in value, thereby taking in a profit.
But that practice is not fashionable anymore these days when the dollar is fast becoming the joke of international currency. To hoard some dollars now hoping and praying that the mighty currency will eventually appreciate in value is like waiting for a miracle to happen.
10. Regulatory Risk
Savvy Investors are always on the look out for changes in the Laws and Regulations that may affect the way of doing business in a particular country or place.
When Martial Law was imposed in this country, for example, it was a signal to the investors that it’s time to pull out and temporarily say goodbye to the Philippines.
11. Political and Geo-Political Risk
This is a broad term which could refer to the general instability of a particular country’s political climate. And yes, it affects investments in more ways than none.
Here are some examples of this type of risk that have beset the Philippines:
- The Martial Law and the reign of dictatorship in the land.
- The Coup d’ Etat during the time of President Corazon Aquino.
- The recent military dispute in Zamboanga.
People hate these things. And investors hate it the most.
Did you ever wonder why some parts of the Philippines, particularly in Mindanao, don’t seem to see the light of economic progress?
It turns out, the biggest businesses and investors in the country not only know where to put their money. They also know very well, where NOT to put their money.
12. Opportunity Risk
They say that you can’t be in two places at the same time. The same is true with investments.
Once you placed your money in one investment, you also miss the chance of investing that same money in another investment instrument which may yield a higher return.
Who Is Afraid of Investing?
There you have it – a dozen different types of risks associated with investing.
How do you feel now? Do you still want to invest knowing that you can lose money anytime?
What do you think is the best approach in dealing with investment risk?
