Types of Investment Risks

No investment is risk-free. Some investment risks may be particular to the investment itself or to the particular asset class. Others may be much broader, for example relating to the country of investment or the economy in general.

Economic risk (also known as systemic risk): Risk inherent in the economy as a whole. In the event of an economic recession, the stock market, the interest rate market and the exchange rate market may all be adversely affected. Economic risk can arise due to recession, failure in prudential regulation or faults in the financial system. Economic risk affects the entire market.

Market risk (also known as unsystemic risk): Risk of volatility in a market or market sector. The “tech boom” and subsequent “tech wreck” in the United States in the late 1990s was an example of the risk of a particular market sector.  Market risk doesn’t affect the entire market.

risk investmentInflation risk: Risk that inflation will adversely affect the performance of your investment.

Interest rate risk: Risk that the value of an investment will change due to a change in interest rates. Changes in interest rates directly affect the value of interest rate securities, such as bonds. Interest rates also have an indirect effect on other investments, such as property and shares.

Exchange rate risk: Risk of fluctuations in exchange rates adversely affecting the value of an investment. A good way to diversify your investment portfolio is to invest overseas, but changes in the exchange rate of the Australian dollar against the currency of the country you invest in can affect the return of your investment.

Liquidity risk: Risk that an investment can’t be easily and quickly converted into cash (bought or sold) at a fair price.

Credit risk (also known as counterparty risk): Risk that the counterparty to a contract will not live up to its contractual obligations.

Political risk (also known as geopolitical risk): Risk that a government will unexpectedly change its policies or implement new regulations, making an investment less attractive. Political risk can also refer to the uncertainty associated with investing in countries with a political climate less stable than our own.

Sovereign risk: Risk that a central bank will alter its foreign exchange regulations and reduce or null the value of foreign exchange contracts.

Country risk: Risk that a country won’t be able to meet its financial commitments.

Company risk: Risk that the company you invest in fails and goes out of business.

Institutional risk (also known as operational risk): Risk of insufficient internal controls, failures in risk management systems, insufficient capital to absorb unanticipated losses, or inadequate governance structures. Institutional risk also refers to the financial standing of a financial institution or a company that invests money on your behalf. The level of institutional risk varies considerably depending on where you invest your money.