Is Investing in Stocks and Bonds Risky?

Different Types of Risk to Consider when Investing

When we think about investing we often consider the risk of financial loss, but it is not the only type of risk and can lead to a rather myopic view on investment strategy. We want to understand different risk-types so that we can be more informed when developing our investment goals and objectives.

What are Some Risks to Consider when Investing?

• Systematic/Unsystematic Risk – Systematic risk is generally comprised of macro-economic factors (inflation, geo-political, currency, etc.) that can influence broader markets. Unsystematic risk, on the other hand, is more specific and applies to a particular industry, segment or business.
• Opportunity Cost – This risk is a bit more insidious. Opportunity cost is essentially the risk of choosing one investment option over another (choosing CDs instead of equity markets, for example.) You are getting the guaranteed return of the CD, but you are missing out on the potential larger gains within equity markets.
• Business Risk – This has to do with the specific operations and management of a particular business. Typically, this applies more to individual stocks, but can also apply to funds should the fund hold a large position in just a few companies. Things like debt obligations, management changes, and potential litigation can have dramatic impacts on a particular business.
• Financial Risk – Yes, there is the risk of loss, but you have to couple that with the potential reward. The Risk-Reward Principle states that with higher potential risks should come potential for greater rewards. Obviously, this is not always the case, but in general we seek bigger returns as the risk profile of the investment increases.

How do You Limit Risk in an Investment Portfolio?

There is no way to completely eliminate risk. We have it in our everyday lives, all around us, and we take certain rational steps to try and limit it. The same is true with our investments, and one of the best ways to limit exposure to risk is through asset-class diversification. Asset classes can have negative correlation meaning that as one class moves up, another moves in an opposite direction. We can take advantage of this movement by investing across different segments of the market so that as one asset class sees a drop in value, another may increase to act as an offset. This is an important part of long-term wealth creation and retirement planning. Diversification can provide downside protection without substantially limiting returns¹.

Clarke, A. W. (2023, May 19). How To Diversify Your Investments And Protect Downside Risk. Retrieved February 19, 2024, from https://www.forbes.com/sites/investor-hub/article/how-to-diversify-your-investments-and-protect-downside-risk/?sh=9d449ce33887