Types of investment risk
When you invest, you’re exposed to different types of risk. Learn how different risks can affect your investment returns.
9 types of investment risk
1. Market risk
The risk of investments declining in value because of economic developments or other events that affect the entire market. The main types of market riskMarket risk The risk of investments declining in value because of economic developments or other events that affect the entire market. The main types of market risk are equity risk, interest rate risk and currency risk.+ read full definition are equity riskEquity risk Equity risk is the risk of loss because of a drop in the market price of shares.+ read full definition, interest rate riskInterest rate risk Interest rate risk applies to debt investments such as bonds. It is the risk of losing money because of a change in the interest rate.+ read full definition and currency riskCurrency risk The risk of losing money because of a movement in the exchange rate. Applies when you own foreign investments.+ read full definition.
- EquityEquity Two meanings: 1. The part of investment you have paid for in cash. Example: you may have equity in a home or a business. 2. Investments in the stock market. Example: equity mutual funds.+ read full definition risk – applies to an investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition in shares. The market priceMarket price The amount you must pay to buy one unit or one share of an investment. The market price can change from day to day or even minute to minute.+ read full definition of shares varies all the time depending on demand and supply. Equity risk is the risk of loss because of a drop in the market price of shares.
- Interest rateInterest rate A fee you pay to borrow money. Or, a fee you get to lend it. Often shown as an annual percentage rate, like 5%. Examples: If you get a loan, you pay interest. If you buy a GIC, the bank pays you interest. It uses your money until you need it back.+ read full definition risk – applies to debtDebt Money that you have borrowed. You must repay the loan, with interest, by a set date.+ read full definition investments such as bonds. It is the risk of losing money because of a change in the interest rate. For example, if the interest rate goes up, the market valueMarket value The value of an investment on the statement date. The market value tells you what your investment is worth as at a certain date. Example: If you had 100 units and the price was $2 on the statement date, their market value would be $200.+ read full definition of bonds will drop.
- Currency risk – applies when you own foreign investments. It is the risk of losing money because of a movement in the exchange rateExchange rate How much one country’s currency is worth in terms of another. In other words, the rate at which one currency can be exchanged for another.+ read full definition. For example, if the U.S. dollar becomes less valuable relative to the Canadian dollar, your U.S. stocks will be worth less in Canadian dollars.
2. Liquidity risk
The risk of being unable to sell your investment at a fair price and get your money out when you want to. To sell the investment, you may need to accept a lower price. In some cases, such as exempt market investments, it may not be possible to sell the investment at all.
3. Concentration risk
The risk of loss because your money is concentrated in 1 investment or type of investment. When you diversify your investments, you spread the risk over different types of investments, industries and geographic locations.
4. Credit risk
The risk that the government entity or company that issued the bondBond A kind of loan you make to the government or a company. They use the money to run their operations. In turn, you get back a set amount of interest once or twice a year. If you hold bonds until the maturity date, you will get all your money back as well. If you sell…+ read full definition will run into financial difficulties and won’t be able to pay the interest or repay the principalPrincipal The total amount of money that you invest, or the total amount of money you owe on a debt.+ read full definition at maturity. Credit riskCredit risk The risk of default that may arise from a borrower failing to make a required payment.+ read full definition applies to debt investments such as bonds. You can evaluate credit risk by looking at the credit ratingCredit rating A way to score a person or company’s ability to repay money that it borrows based on credit and payment history. Your credit score is based on your borrowing history and financial situation, including your savings and debts.+ read full definition of the bond. For example, long-termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition Canadian government bonds have a credit rating of AAA, which indicates the lowest possible credit risk.
5. Reinvestment risk
The risk of loss from reinvesting principal or income at a lower interest rate. Suppose you buy a bond paying 5%. Reinvestment riskReinvestment risk The risk of loss from reinvesting principal or income at a lower interest rate.+ read full definition will affect you if interest rates drop and you have to reinvest the regular interest payments at 4%. Reinvestment risk will also apply if the bond matures and you have to reinvest the principal at less than 5%. Reinvestment risk will not apply if you intend to spend the regular interest payments or the principal at maturity.
6. Inflation risk
The risk of a loss in your purchasing power because the value of your investments does not keep up with inflationInflation A rise in the cost of goods and services over a set period of time. This means a dollar can buy fewer goods over time. In most cases, inflation is measured by the Consumer Price Index.+ read full definition. Inflation erodes the purchasing power of money over time – the same amount of money will buy fewer goods and services. Inflation riskInflation risk The risk of a loss in your purchasing power because the value of your investments does not keep up with inflation.+ read full definition is particularly relevant if you own cash or debt investments like bonds. Shares offer some protection against inflation because most companies can increase the prices they charge to their customers. ShareShare A piece of ownership in a company. A share does not give you direct control over the company’s daily operations. But it does let you get a share of profits if the company pays dividends.+ read full definition prices should therefore rise in line with inflation. Real estateEstate The total sum of money and property you leave behind when you die.+ read full definition also offers some protection because landlords can increase rents over time.
7. Horizon risk
The risk that your investment horizon may be shortened because of an unforeseen event, for example, the loss of your job. This may force you to sell investments that you were expecting to hold for the long term. If you must sell at a time when the markets are down, you may lose money.
8. Longevity risk
The risk of outliving your savings. This risk is particularly relevant for people who are retired, or are nearing retirement.
9. Foreign investment risk
The risk of loss when investing in foreign countries. When you buy foreign investments, for example, the shares of companies in emerging markets, you face risks that do not exist in Canada, for example, the risk of nationalization.
Various types of risk need to be considered at various investing stages and for different goals.
Review your existing investments. Which risks affect you? Are you comfortable taking these risks?