Investing money always involves some risk, especially if you’ve set some bigger goals for yourself. The good news is that it is possible to minimize this risk in the market by doing good risk management. This article may help you understand this concept a bit better.
Decisions always come with some amount of risk, and it is no different when it comes to financial investment. However, to achieve that much-desired goal, exposure to market threats becomes a necessary evil. But did you know that with good investment risk management, you could minimize your exposure to these risks while also maximizing your return?
In this article, you’ll learn about the main investment risks, the profiles of investors, and how this influences the return on the money you invested. Let’s get started!
What is investment risk?
When it comes to the financial market, investment and risk are two sides of the same coin. No matter how safe the investment may be, there is always the chance you’ll lose money, although sometimes the probability is barely above zero.
On the other hand, the lower the risk, the lower the chances of you turning a profit on said investment. In contrast, riskier opportunities tend to offer greater chances of a return to the investor.
Main types of investment risks
As already mentioned, there isn’t a risk-free option when investing in the financial market, and it is up to you to make the best choices. You can do this by factoring in your investor profile and the financial return objectives you’re gunning for.
Below, we’ll present 3 of the main investment risks: market, liquidity, and credit.
Market risk
Market risk is on the list of systemic risks, as it affects different assets to some extent. It is linked to movements in the financial market, such as changes in interest rates, exchange rate fluctuations, and inflation. If the market is oscillating a lot, you’re probably not going to get the return you were hoping for.
Liquidity risk
Liquidity refers to the ability to easily convert an investment into cash. Based on the type of investment you opted for, liquidity can be high or low.
Savings is a highly liquid investment option, and you can withdraw your capital at any time. Because of this, the possibility of financial losses is significantly lower. In line with this though, the yield is also very small.
An investment with less liquidity has a higher financial return, but it also offers more risk, since the investor is prevented from moving his money for a longer period of time. This leaves you vulnerable to market fluctuations, effectively losing you money if you guessed wrong.
Credit risk
Credit risk is a common term in institutions that offer loans and other financial products to customers. This is mainly because they’re aware of the possibility that the borrower doesn’t return the loan. To circumvent this, lenders perform thorough credit risk analysis before going through with a deal.
The same risk can affect an investor who buys bonds or invests his money in a financial institution, as there’s always the possibility of it going bankrupt. Therefore, it’s highly important to rely on expert help to assess the best way to avoid credit risk. By this logic, investments covered by the Credit Guarantee Fund are always the safest.
How does risk influence investments?
We’ve said before that the greater the risk, the greater the possibility of profit on the money invested, right? Therefore, before taking any decision, you should perform your due diligence and inform yourself of the characteristics of your investment.
You should also take into account your willingness to take more or less risk, your options between higher and lower liquidity investments, and the objective of financial return.
These aspects will help define your investment profile. Generally, there are three types of investors: conservative, moderate, and aggressive. Below you’ll find detailed explanations for each of those 3 and discover the one you relate to the most.
Conservative
Conservative investors have the lowest tolerance for the risk of losing funds. For them, the most important thing is preserving their assets and moving them whenever they feel it’s necessary. Because of this, they invest in highly-liquid funds and choose times when the market is fairly calm. Despite the security they gain, they tend to have a lower return on their investment.
Moderate
A moderate investor still values the security of his assets, but he understands that better financial returns require him to take some risk. Due to this approach, moderate investors usually commit only half of their money to long-term goals, while also sticking to more secure investments.
Aggressive
Also known as bold, aggressive investors tend to have greater knowledge of the financial market and also have a greater tolerance for the risk of losing money. However, this only pays off if their investment actually returns, and wasn’t a miss.
What is the role of investment risk management?
Regardless of the type of investor, the truth is that nobody wants to lose money. But the return on investment can help you create a more comfortable life for yourself and your family. Once you’ve reached your first goal, you’ll understand why making such high-risk investments was worth it.
In this scenario, investment risk management plays an important role. Knowing the pros and cons of each type of investment and being aware of fluctuations in the market will help you cut your losses down to a minimum.
However, if you’re new to the market, you probably don’t have the necessary knowledge to make calculated decisions, and you may want to rely on a professional instead.
How to increase the security of your investment?
Investing in fixed-income funds is always the safest option, although it does offer minuscule returns that may bring no change in your life.
If you’re looking for much more significant profits, you may have to go for some riskier options out on the market. Get to know the company’s history, the current situation, and the possibility of bankruptcy or being heavily impacted by market fluctuations.
This research can be extremely difficult for anyone with no experience, and it’s why seeking the help of a specialized risk management company is recommended.
The third tip is to diversify your investment portfolio. This reduces your exposure to risk, as market fluctuations impact each investment fund to a different degree. Specialized risk management is a good request in this regard as well.