Dictionary meaning of risk is the situation involving exposure to danger, the likelihood of something going against as planned. Before we talk about what are different types of investment risk, they are broadly classified as systematic (huge coverage) and unsystematic one (specific coverage).
Systematic risk is applicable to the entire market place. Whatever be the type of investment they come with some in-built risk. Like war or war like situation, an untimely collapse of government etc. The whole market may collapse and it is not possible to protect one’s portfolio from it. Even if one diversifies his holdings he cannot escape the market downfall.
Unsystematic is a specific risk. It affects particular segments of the market, or specific company or specific sector or industry. Like losing a lawsuit, strike by employees, etc. being specific to a certain company. One can control the loss by diversifying investments in portfolio by way of investing into another company or sector.
Apart from these above two broad classifications, there are certain specific types which an investor should know.
- Inflation Risk
The real return on your investments gets eroded because of high inflation. If inflation is too high then real returns on your investments can be negative too. In short, your returns should beat inflation by a big margin.
If you invest in FD and get 8% interest per year. And if inflation is 5% then your real return is 3%. But if you invest some financial product where you get 12% return per year than you beat inflation by 7%. In short better the rates of return less susceptible you are towards inflation risk.
- Market Risk
Value of your investment may fall due to market risk factors. They can be equity risk (stock market risk), interest rate risk (interest rate fluctuation), currency risk (fluctuation in currency vis-a-vis another currency), and commodity risk (fluctuating in commodity prices)
- Credit risk
It is a risk of debt obligation not met. A person or a company who has taken credit from you are unable to pay interest or is unable to return your principal amount.
Government bonds purchased usually has lowest credit risk. In other words investments in government bonds, you are sure to get your investment back along with interest (almost sure but not 100% sure) Though private companies have just a little bit higher credit risk.
Before investing one should check the company’s credit rating by knowing its standing, by reputed rating agencies like CRISIL or CARE or ICRA.
Even banks fixed deposit has some credit risk. In case bank liquidates one will get back the maximum of Rs. 1 Lac as guaranteed by the government.
- Country Risk
When ever a country (like Greece) is unable to keep its debt obligations that is defaults its payments, its effects other countries with which it has financial relations and bonds, mutual fund, shares and other financial investment are affected.
Underdeveloped and to some extent developing countries are more at risk as compared to developed ones.
The above risk can be at the micro level (individual) or macro level (country) but they are sure to affect your investments, usually in long run. So it is better that before investing in any financial instruments we should take the risk involved in our investment into account.