To some people, bungee jumping off high bridges is fun. To others, a leap off a five-metre diving board would be unthinkable. It all depends on your tolerance for risks.
When investing, you have to limit your risks to a level acceptable to you.
There is no such thing as a risk-free investment. Even cash under your mattress could be stolen; deposits could be wiped out if your bank collapses. So, before committing to any investment, you must make sure you understand the possible downside.
What are the risks you face when investing?
Market risk: Prices of stocks, bonds and currencies can be very volatile and unpredictable subject to different market and economic factors both locally and internationally.
Market risk, also known as systematic risk, usually refers to that type of risk associated to a specific market. It stems from the economic, geographical, political, social or other factors of that market. You may click here to know more about systematic risk.
Interest rate risk: Shifts in interest rates affect a wide range of investments - including bank deposits, stocks, bonds and property. Whichever way interest rates shift, there are gainers and losers. Rises in interest rates are good for saving deposits, but generally cause pain to stock and bond holders, and property investors with mortgages. Generally, bond prices fall in response to a rise in interest rates, and long term bonds with a higher duration are likely to be more sensitive to interest rate changes. Cuts in interest rates hurt those with large amount of saving deposits.
Business risk: A company you invest in may suffer a severe decline in profits or even goes bankrupt. This could be a result of many factors such as poor management, slowdown of the industry and competition.
Corporate misgovernance: A company you invest in may conduct a corporate transaction that you deem detrimental to your interests as a shareholder, e.g. a company buys an over-valued asset.
Currency risk: Overseas investments can be badly hit if currencies suddenly turn against you.
Inflation risk: Increases in the price level can eat away the value of your capital and reduce your purchasing power. Retired people living on a fixed capital sum may see their savings, and quality of life, whittling away in times of high inflation.
Liquidity risk: Tying up investments in products which are hard to liquidate, or carry heavy costs for liquidation, can prove a burden. In the stock market, second liners are generally less liquid than large caps.
Policy risk: Changes in government policies and regulations could have profound impact on your investments. Also, ambiguous and erratic rules and policies could cast uncertainty on your investments. Policy risk is particularly crucial for investing in emerging markets.
Scams: You may be seriously harmed regardless of the performance of your investments. The best way to keep away from investment scams are using common sense and taking precautions. Avoid get-rich-quick schemes.
Broker failure: If your broker defaults or goes bankrupt, you may find your investments at risk. Always be sensible and only deal with licensed, reputable brokers.