Welcome back to the Successful Financial Strategies blog! In our last blog post, we talked about why it is better to invest in financial planning instead of robbing a bank. We, of course, were speaking in a tongue-in-cheek manner about this topic, because most people would never seriously consider robbing a bank. However, some employ the same thought process to their financials that anyone who is thinking of robbing a bank for financial means would apply: high-risk investments that can make you rich fast aren’t the most productive means for gaining prosperity. Today, we are going to talk about this topic even further.
What is Risk?
Risk is defined by the Merriam-Webster dictionary as “possibility of loss or injury; someone or something that creates or suggests a hazard, and the chance that an investment (such as a stock or commodity) will lose value.” However, risk when speaking technically about investments is a little tricker. Risk is often seen as underperformance; an investment was expected to perform at 10 percent and it performed at eight, but this is not truly risk. Volatility has also been defined as risk, but volatility does measure the likelihood of an outcome, but allows for more possible outcomes. Risk is loosely defined by this article as “a loss of capital or underperformance relative to expectations” which will work for the purpose of defining high and low risk investments.
A High-Risk Vs. a Low Risk Investment
Therefore, a high-risk investment can be understood as one that incurs a loss in capital or performs less than expected. Conversely, a low risk investment can be defined as one in which presents less potential loss of capital and has a higher likelihood of performing as expected or exceeding those expectations.
5 Types of Risks
When you invest, your financial planning advisor in Hendersonville may discuss risk in terms of not only risk management, but also five specific types of risk which we will define below. Risk management involves defining and accepting those risk factors associated with a particular investment. Also, some investment products will always have inherent risks associated with them and other investments opportunities with come with their own types of risks. There are five types of risks that you may encounter when investing.
Business Risk – dependent on a company’s loss of value due to hard-to-foresee changes.
Call Risk – when a company will repay a bond or call back a bond earlier than expected.
Allocation Risk – when you invest in a particular type of investment. This can occur when you choose investments that aren’t in your best interest.
Political Risk – political climates can affect your investments.
Dividend Risk – incur dividend risk when a company reduces or cuts their dividends.
When it comes to investing and risk, unfortunately you will never be able to have complete control over the outcomes of your investments. However, managing your risks and constructing a well-diversified portfolio can be safe-guards. To learn more about creating your portfolio, financial planning, and more, speak to a financial advisor at Successful Financial Strategies. We provide financial guidance for clients in Hendersonville.