Investment Risk: Pick Your Poison

In talking with investors, often I hear the response, “I don’t wanna take any risk.” However, what they sometimes overlook is that there’s really no such thing as a “risk-free” investment (although there are some things that come pretty close that act as proxy, which we may talk about another time).

So let’s talk about risk in general terms.

1. Inflation/Purchasing Power Risk
1. Inflation can impact the performance of the actual businesses we invest in as they have to battle inflationary forces.
2. Impacts the purchasing power of your return (i.e. costs of goods of services increase, after-inflation (“real”) rate of return will be less than your nominal return).
2. Interest Risk
1. Price Risk—when interests change, the assessed value of investments change.
2. Reinvestment Rate Risk—the principal or interest paid out in the future, interest rates could be different.
3. Business Risk (unsystematic risk)—your investment could be affected by the individual business you invest in. This risk can normally be diversified away.
4. Financial Risk—the more debt a business uses to finance its operations, the greater the variability in the returns, putting your investment at greater risk.
5. Default Risk—the company you invest in could default on its obligations to pay you, the investor.
6. Liquidity Risk—how quickly you can convert an asset to cash with little or no price concession.
7. Marketability Risk—ease of selling an asset for its fair market value.
8. Political—political instability, wars, trade disputes, etc. can put your investment at risk.
9. Sovereign Risk—the risk a government may not make good on its promises to pay investors as promised (similar to default risk).
10. Exchange Rate Risk—fluctuating currency exchange rates could put your investment at risk.
11. Tax Risk—the ever-changing tax landscape will always pose some risk to your investments
12. Investment Manager Risk—applicable mostly to managed investments like mutual funds. The money manager potentially adds an additional element of risk.
13. Additional Commitment Risk—what happens if your investment requires additional commitment.
14. Physical—I put this on here as it applies to physical possession of investments, like cash on hand, physical stock certificates, physical gold, etc. that those investments could be lost, stolen or damaged.

Key take-aways:

1. No investment is really without risk
2. Investing is about understanding the risks and managing them wisely

Action: take a look at your holdings and see what risks each might be subject to.