Types Of Investment Risks To Watch Out For

There are various types of risks we are faced with while investing. An understanding of them will serve as guide on our investment journey

*There are various types of risks we are faced with while investing. An understanding of them will serve as guide on our investment journey.*

One of the most important things we do daily is make decisions. What to eat, what to wear, what route to follow, the next move to make, and so on. These decisions, even as minute as some of them are, represent the pieces that come together to determine who we are.

In other words, making the wrong decision like choosing to sleep for one more hour instead of going for that meeting could cost you a lot! Within every decision made or unmade lies a risk and it is how we choose to manage this risk that determines whether we soar, remain static, or retrogress.

And just like any problem, the best way to solve it is to find a solution before It occurs.

In life, risks are either pronounced and apparent – like quitting your job without any expected source of income – or invisible like choosing to follow a route only to find out that and the street has been blocked because of a party.

As such, there are risks within your control and those that are not within your control. In investment as well, there are broadly two types of risks and they are known as systematic and unsystematic risks.

Systematic Risks

Systematic risk simply refers to risk that is not within your control. Also known as market risk, it represents all the unforeseen events that cannot be controlled by investors themselves.

Some examples of this includes the passing of a new law that affects your business adversely, the outbreak of a disease, the risk of war, recessions, and so on. They are typically caused by macroeconomic factors within an economy and it is almost impossible to avoid their impact.

The only kinds of investments that have no systematic risks are treasury bills and certificates of deposit. While diversification cannot protect you from the impact of systematic risk, it can be mitigated through hedging.

Unsystematic Risks

On the flip side, unsystematic risk refers to risks that are based on decisions you make. They are thus, avoidable. Unsystematic risks are caused by factors that are within the control of companies, such as mismanagement or negligence.

An example of this is a company’s staff going on strike or the company having tax issues. In order to mitigate the impact of unsystematic risk, you would need to diversify your portfolio so that the loss on one can be offset by the gains on another.

Systematic + Unsystematic Risk = Total Risk.

While all forms of risks are broadly covered in systematic and unsystematic risk, there are other forms of risks based on their specific features. Some of them include:

Market Risk

This is the kind of risk that happens when you invest in the stock market. It comes with the natural flow of the market which moves from bust to boom and back.

This is why investors are encouraged to invest for a long time because in the short run, market risk could make your investment seem like it’s not worth it.

Liquidity Risk

Liquidity risk refers to the type of risk that occurs when a company is not solvent enough to meet all its immediate financial needs. In the stock market, it refers to the scenario where a company is unable to sell or obtain funds from investments as required.

Business Risk

As the name implies, business risk refers to the type of risk that is peculiar to the type of business being run and its industry. For example, if there is crisis with the milk supply of the country, all the companies that require milk as a raw material would take the hit.

As an unsystematic risk, a simple way to avoid it risk is by diversifying your investment portfolio.

Currency Risk or Foreign Exchange Risk

This risk is one of the primary reasons for the last recession we faced in Nigeria. It is peculiar to businesses that are carried out in foreign currencies and occurs when there is a change in the value of one currency against another.

Concentration Risk

This is also commonly referred to as the risk of ‘one’. This refers to a situation where your investment is focused in one country/geographical location, one industry, and so on. What this means is that when something adverse takes place, it affects all your investments at the same time.

Political risk

Political risk occurs when a country’s political terrain is unstable making it worrisome for foreign investors to come in. It is usually as a result of a country’s unfavorable policies or international perception of it.

An understanding of these risks will reveal actions to take to mitigate them. In our next post, we’ll share ways on how these risks can be mitigated for optimal results.

Article by Lawretta Egba