“The greater the risk, the greater the reward” is heard everywhere, including when it comes to the stock market. Riskier assets, such as emerging market stocks are riskier than bonds, and as a result, lead to greater returns over time. But what exactly is risk? The definition of risk is exposing oneself to danger, harm or loss. But risk is a general term. There are many examples of risks when investing. In this post, I will introduce you to most of the forms of risk when investing in the stock market.
9 Risks When Investing You Need To Understand
#1. Business Risk
Business risk is simply being involved in an industry. For example, a company that does business selling cars runs the risk of not selling cars because of a recession in the economy or a hiccup in production. The company cannot control this risk.
A perfect example is the Firestone tire issue a few years ago. As a result of faulty tires, both Firestone and Ford faced serious business risk.
As an investor buying shares of said company, you face this risk. If the company isn’t selling cars, the stock price will drop.
#2. Market Risk
This is the risk you take when investing in the stock market. If the market drops, you lose money and vice versa. This is due to the market as a whole declining and not a result of a specific security losing value.
Every day, market risk presents itself again as no one knows what the market will do that day. It is a risk that you cannot avoid when you invest in the stock market. As an investor, you just have to take it into account.
#3. Currency Risk
Another example of one of the risks when investing is currency risk. If you invest in foreign companies, you can lose money simply by having the dollar appreciate or depreciate in value. When this happens, the value of the foreign company shares is worth more or less to you.
You saw this happen when the UK decided to leave the European Union. The value of the British Pound dropped greatly in value. If you were investing in any UK stocks, you took a hit.
You also face this risk when you trade in currencies as well. This risk is not limited to just stocks, but forex trading as well.
#4. Credit Risk
If a company issues bonds to the public and then defaults on the payments or enters into bankruptcy, you risk losing your money.
This can be a large issue since so many companies issues bonds with a time horizon of 5 years or longer. You have no idea what is going to happen in the future. Just ask Lehman Brothers bondholders.
The good news with credit risk as it relates to bonds is that as a bondholder, you are first in line to get your money back. This isn’t to say you definitely will get your money back, but you have priority versus stockholders.