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All Kinds Of Risk That Affect Your Investments

When someone asks me “tell me some risk free investment which can generate good returns” – I get confused. Why? Because according to me there are n number of risks in investing & I am not sure which risk he is talking about. Warren Buffett Said “Risk comes from not knowing what you are doing”  so today let’s risk ourselves to understand different types of risks that are associated with equity & debt investments.

What is Risk ?

What comes to your mind when someone says RISK or this investment is risky? Risk for most of the people has only one meaning loosing the principal amount. In scientific language “Risk may be taken as downside risk, the difference between the actual return and the expected return (when the actual return is less), or the uncertainty of that return.”

All kinds of investment risks:

Investment Risk:

It is about possibility of losing money. Today you invest Rs 5 lakh in equity & get Rs 4 after 3 years. Investment risk can be measured by Standard Deviation.

Inflation Risk:

It is losing purchasing power of money. In 2011 you invest Rs 5 Lakh in debt & get Rs 10 Lakh in 2020. But your Rs 10 Lakh is not able to buy you the item which was available for Rs 4 Lakh in 2011.

Systematic Risk:

It is also known as market risk or economic risk or non diversifiable risk & it impacts full economy or share market. Let’s say if interest rate will increase whole economy will slow down & there is no way to hide from this impact. As such there is no way to reduce systematic risk other than investing your money in some other country.

Unsystematic Risk:

It affects a small part of economy or sometime even single company. Bad management or low demand in some particular sector will impact a single company or a single sector – such risks can be reduced by diversifying once investments. So this is also called Diversifiable Risk.

Interest Rate Risk:

Change in interest rate will impact price of bonds (or NCDs). There is negative relation between price of bond & interest rates – if interest rate will increase price of bond will go down & vice versa.

Reinvestment Risk:

Let’s assume that you made investment in a bond with 9% yearly interest. Interest rate reduced to 7% in 1 year so next year when you received interest & went back to invest it was invested at lower rate.

Liquidity Risk:

If you have some bonds that you would like to sell for immediate requirement but there is no buyer or fewer buyers than sellers – you may have to sell your bonds at discount.

Country risk:

It is also called sovereign risk. As you read in Credit risk “Credit risk is close to zero in Government Bonds” but close to zero doesn’t mean zero. What about present condition of PIGS – Portugal, Ireland, Greece & Spain. Even in India there have been instances where fixed deposits issued by govt backed companies deferred maturity payments by issuing additional bonds.

Inflation Risk:

As mentioned in starting of the article. Inflation is your biggest enemy.

Exchange Rate Risk:

If you invest in debt or equity of some other country you will face exchange rate risk. If some of your US investments earn 10% in one year in dollar terms but the same year dollar loose 2% in comparison to rupee – your actual return will be 8%. NRIs are heavily impacted by this risk & they should make financial decision after considering it.

Timing Risk:

I don’t think I need to explain it but only one suggestion – don’t take this risk.

Volatility Risk:

Equity prices keep fluctuating on day to day basis. This can be measured by standard deviation.

Political Risk or government risk or regulator risk:

What will happen if you have invested in a particular sector & government comes out with an adverse policy. This risk can be clearly seen in sugar or oil & gas sector.

Valuation Risk:

You may find a great company with great future prospects but if present valuation is too high you will not make money. Infosys was good company in 2000 & great company in 2005 but its price of 2005 peak was less than 2000.

Business Risk & Technology Risk:

Couple of years back pagers & typewriters were important part of once life but these products are no more there. Same happened with Audio tapes & floppies – what would have happened to these companies.

Execution risk:

The time between when you see your price and when the trade actually goes to the market.

Concentration Risk:

When you invest in single company (I know a person who invested all his long term savings in Satyam), single fund or single asset management company you are actually taking a huge risk.

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