Investments are the basic cogs in your wealth creation machine, so they can’t be wished away. Nor can their inherent risks and complications be underestimated. Part of the process is staking your hard-earned money in some high-risk, often volatile financial instruments – wealth creation asks for a lot of risk-taking; basic contingency and other cash can be parked in safer savings accounts.
So how do you assess ‘risk’? Professional financiers and consultants will be able to walk you through the nitty-gritty of your personal investments using multiple tools of assessment and often some standard deviation calculations.
But you, personally, should be aware of some fundamental risks that attach themselves to every investment, at most moments in an economic cycle.
1. Liquidity Risk
This is tied to your re-sale possibilities. We invest to hedge our money for the future, or for tough circumstances. But even the healthy stocks in your kitty may not find a buyer in the market when you are in need for some liquidity. Your prospect of a good deal depends on the presence of a good buyer on the other end, and that buyer may not be available when you want it.
2. Default/Credit Risk
Even the conventionally trustworthy investment item on your portfolio isn’t immune to this risk. In the event of a financial mismanagement scandal, or a sudden change in ownership, you may find your stocks dramatically undervalued or even defunct.
3. Interest Rate Risk
Changes in the interest rate directly affect the corpus of your investment, and these changes happen in the realm of all financial institutions, even with relation to fixed deposit schemes. So your anticipation of 5% interest on X amount over a Y period will be derailed if in the midst the rate changes to 4.5%.
4. Inflation Risk
This is a sword that hangs on all our financial activities, at all times! Inflationary pressures – simply the rise in the prices of consumable goods – can weaken your savings in a short period of time. Your purchasing power and wealth-creation mettle is tied to how the prices fluctuate, and though it is a factor of many variables, you need to be aware of it enough to put in place some reasonable protections against it.
5. Policy Risk
Government changes often bring with them changes in long-held financial policies (like the recent spate of ‘austerity’ measures in Europe). They are also influenced by current economic conditions, the labour market movements, country debt rates, etc. These changes can directly affect your liquidity and the returns on your stocks, especially your government bonds.
6. Market Risk
Market crashes have wreaked much havoc in the past, and there are no signs of them disappearing in the future, with even the most solid companies at risk of defaulting on payments or crumbling altogether. Think Enron.
7. Mortality Risk
This is a factor of calculation – you estimate your life span as the ‘long-term’ and save accordingly. But life has no guarantees, and this span may be shorter, or longer, than imagined. In either case, you risk not getting the full value on your payments, or of outliving them in a haze of liquidity crunch.
8. Risk of Information
How do you build your portfolio? Based on news, company reports, advertisements, endorsements, professional advice? How much trust can you really invest in these sources? Information is inherently a tricky thing, so it is difficult for us to gauge how much of it may be rigged, biased, and plain insufficient.
9. Global Risks
Where you invest is of course critical. If you are an international investor, then your risk net spreads wider and gets affected by specific country laws and policies, foreign exchange rates, natural disasters, even terrorist attacks, and so much more.
10. Technology Risk
Obsolescence is one of the greatest levellers of our times. If you invest heavily in technology companies or in research, your returns will only be as good as the product and its shelf-life. Technologies change and get upgraded constantly, so your window of investment and resale here may be rather small and hyper-competitive.