Understanding risks associated with investments

However, the scope of the term risk is generally restricted to the price volatility associated with an asset or investment.

Feb 19, 2015 07:02 IST India Infoline News Service

Risk and Reward are the two terms that are used extensively in financial planning. However, the scope of the term risk is generally restricted to the price volatility associated with an asset or investment. In simpler words, risk means chances that an investment will provide lower return than the returns expected while there is a danger of incurring losses as well. Any investment comes with risk, which could mean either principal loss or a failed investment strategy. However, there are other types of risk present in a market that could impact one's investments.
 
These risks are explained as under:
 
Market Risk: This risk refers to broader market risk that comes due to a general decline in the financial markets. One may not provide 100% cushion against such market risk.
 
Inflation Risk: An investment delivers returns but a higher inflation rate than the yield could mean a loss to an investor. For example, an investment returned 8% return, while the inflation rose by 10%, which means that the invested sum would buy less than the same money in hand today.
 
Reinvestment Rate Risk: There is a probability that funds will be reinvested at a lower rate over the original rate of investment. This risk holds true for debt and fixed deposits, where the matured sum runs the risk of being invested at lower rates.
 
Interest Rate Risk: This risk arises with the change in interest rates, which results in price fluctuations, mainly in debt instruments. An interest rate rise leads to fall in bond prices and vice versa.
 
Liquidity Risk: A liquidity risk refers to a risk of how soon investments could be converted into cash. Large-cap stocks are considered as highly liquid while real estate investments are considered as illiquid.
 
Political Risks: Political risk arises when a change in government or legislation impacts the companies or businesses an investor has invested in. 

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