The Types of Risk Face by Stock Investor
Any investment carries a certain amount of risk. Risk can be defined as the chance of unexpected outcomes affecting the expected investing returns. As the saying goes in the investing world, the higher the risk, the higher the reward. But it doesn’t mean one takes an unnecessary risk with their investment. Some risks are manageable while others can be reduced with a change in the portfolio according to the situation. A successful investor knows how to manage risk rather than avoiding it. Let’s look at some of the risk a stock market investor faces in the capital market.
- Liquidity Risk: It is mainly the risk of being unable to sell his/her investment at a given price. This usually occurs due to the inability to convert a security into cash without a loss of capital. It mainly shows the demand for security is quite low. In the share market, it is easily reflected in bid-ask spreads.
- Market Risk: The risk of an investment that prices of the security will move in an undesirable direction that impacts the overall value of one’s holding. It is systematic risk and is based on the price fluctuation on a day to day basis in the market. For example, If a person buys a forward contract to buy oil for a price of $90 per barrel, but the price of oil moves down to $70 per barrel at the time the contract matures due to low demand for oil in the market.
- Business Risk: It is mainly the risk associated with the business. The risk will be higher if the business is not doing well for a long period of time. The reason could be either due to failure of management policy, poor quarter to quarter result and due to the threat of substitutes. In order to avoid business risk, it’s better to invest in companies with different business models.
- Inflation Risk: It is mainly the risk associated with loss in purchasing power because the value of your investment does not keep up with inflation. For example, If an investor is expecting consumer price inflation at 3.2% year on year, however, it comes out to be 4.5%. It certainly puts a negative impact on your returns, especially those who invest in fixed income interests or sectors that provide moderate returns.
- Credit Risk: The risk associated with a company with the possibility of failure to repay a loan. It can refer to the risk that a lender may not receive the owner’s principal and interest. In such a scenario, there is a negative impact on the share’s prices. So, before investing in any company, always looked upon the company debt with the help of financial ratios such as debt to equity ratio. It will give you a general idea of how much debt the company has or whether it’s good to invest in it.
- Interest rate risk: An interest rate plays an important role in the stock market investing. The rates keep changing from time to time, affecting positively as well negatively to the stock market depending upon the direction in which the interest rate is moving. If the interest rate is high, a company will hardly borrow money for the expansion which will affect the future prices of the share. Similarly, a lower interest rate allows a company to borrow money and expand its operation, which will make a positive impact on share price in the future.
- Regulatory risk: There are certain companies that require extreme regulation to pass in order to operate such as cigarettes, telecommunication, and pharmaceutical. Any changes in regulation directly impact the share price. For example, if a pharma company loses any of its drug patents due to a regulatory effect, then it will certainly affect the company’s profit and hence the stock price. So, it’s better to be an avid watcher before investing in such stocks.
So, before investing in any risk one should access the amount of risk apart from looking at these basic risks. Never be worried about short term fluctuations until it exceeds your risk profile.
*Disclaimer: investment in securities market are subject to market risks, read all the related documents carefully before investing