4 Different Types of Risks in the Stock Market You Shouldn’t Discard
“Risk is uncertainty, and in uncertainty lies opportunity”… Lorayne Fiorillo
When you invest, you’re vulnerable to different risks, as risk is inherent in any investment. It is proportional to fluctuation in stock prices. The higher the fluctuation, the higher the risk. Usually, risks measure the DOV (Degree of Variation) in the returns. However, not every retail investor can understand the meaning and implication of risks on returns.
Investors believe in ‘high risk, high gain,’ ‘no risk, no gain.’ These terms have become commonplace among them. However, if this were the case, everyone would put their investment on high risk and expect high returns. It’s a myth. The risk may involve high loss too, and the same can be experienced in many previous cases. It’s better to join stock trading classes and learn how to analyze different types of risks and how these risks can affect your investment returns.
In this article, we have tried to highlight 4 different types of risks in investment.
*1. Inflationary Risk *
The inflationary risk is the risk of future inflation that may cause the purchasing power of cash flow to decline. It is the most perilous risk when it comes to bond investments. It leads to slashing the actual return on investment. The interest rate declared in any bond is the minimal return. If there is a higher inflation rate, it means lower real return. This means that if the inflation is more, the real return can turn out to be negative.
*2. Investment Risk *
“Investment risk can be defined as the probability or likelihood of occurrence of losses relative to the expected return on any particular investment.” The Economic Times.
Stock prices change every day as a result of market forces. The risk in any investment measures the degree of fluctuation in the stock prices. It reveals the probability of losing the invested capital. Higher the probability, higher the investment risks. The possibility or likelihood of losing the investment diverges with the fluctuations in the returns. That’s why experts call stocks high-risk investment, because investors may experience severe swings as the markets fluctuate.
3. Risks in Interest Rate
This type of risk is the probability that a fixed-rate on bond prices will drop in value owing to the rise in interest rates. Bond investments are subject to risks in interest rates. Whenever you buy securities that provide a fixed rate of return, you’re more vulnerable to interest rate risk.
There is an inverse relationship between the interest rate and the bond prices. When the bond prices go down, the interest rate goes up and vice-versa. A reduction in interest rate leads to making bank deposits less attractive and increasing the demand for bonds. It causes a steep hike in bond’s prices.
The reverse happens in case of upward movements of interest rates. Bank deposits become more attractive when the interest rate goes up, compared to bonds. Hence, bond prices go down.
*4. Risk of Bankruptcy *
Bankruptcy risk is more perceptible in corporate bonds as the company may be unable to earn enough to pay the interest promised or it may go bankrupt. There are rare chances that governments go bankrupt or default too; in many previous cases, it has happened. Russia, Brazil, and a few other countries have defaulted. Since this is extremely rare, considering Government bonds risk-free on this parameter is not wrong.
The risk is ingrained in any investment. It’s, therefore, vital to understanding risks thoroughly before plunging into the stock market. Joining an effective stock trading class can hone your skills and improve knowledge of stocks. It can empower you to anticipate risks. So, before stepping into the market, enroll for good stock treading classes.