Understanding types of risk
When it comes to investing, the general rule is that the higher the expected returns, the greater the level of risk you assume. Here’s a summary of some factors that affect the value of an investment.
When it comes to investing, the general rule is that the higher the expected returns, the greater the level of risk you assume. This risk comes in different forms. Here’s a summary of some factors that affect the value of an investment.
Even if you do all your homework – including checking out the business and analysing the outlook for the economy, there’s still a chance that your investment will lose money. That’s because prices are influenced by movements in the market as a whole, and since human emotions play a part in the way the market behaves, these fluctuations can be unpredictable, sometimes even irrational. A related risk is the chance that you won’t be able to sell your investment at an acceptable price. If there is no buyer at the time you want to sell it, chances are, you won’t get a good price for it.
Purchasing power risk
It may seem that there’s no risk involved inuying a security that guarantees the return of your original investment. Fixed-term investments such as GICs and term deposits do so; some securities such as Canada Savings Bonds and money-market funds, also come with a pretty good guarantee that your capital will be returned. However, there’s always a risk that inflation, which represents the cost of living, will outstrip the interest that you earn.
There’s a chance that the company issuing your stock or bond won’t be able to make scheduled dividend or interest payments, so the financial health of the company is a consideration for investors.
Also known as exchange-rate risk, this risk stems from the fact that the companies in which you hold stock or in which your mutual fund invests might be doing business in other countries. Whether a company is based in Canada or abroad, any profits generated by its foreign business activities would have to be converted from the operating currency to Canadian dollars when it comes time for you to realize these gains. Depending on the exchange rate for the Canadian dollar, your investment could lose or gain.
This type of risk may be greater in overseas regions but it also exists here at home. A company’s profits and consequently, your investment, can be affected by changing government regulations and industry rules. For instance, changes in government policy could mean higher corporate tax rates or more restrictive business legislation; there’s also a risk that political upheaval – more likely in some areas of the world than in others – could affect business activities. All these factors can have an impact on a company’s earnings and profits.