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Understanding Risk

When being new to investing you need to know going in that there are numerous risks.


Business Risk:

You purchase a stake in a corporation when you buy a stock.  You are lending money to a corporation by purchasing a bond.  The company must continue to operate in order to receive returns on both of these investments. Common stockholders are the last to receive a payout if a firm declares bankruptcy and liquidates its assets.  If there are assets, preferred stockholders will be compensated after the bondholders of the company.  Common stockholders receive whatever is left over, which could be nothing. Make sure that you consider the financial stability of the insurance firm issuing the annuity into account when buying one.  You want to confirm that the business will endure and be financially stable.

Volatility Risk:

Companies' stock prices can change even when they are not in danger of falling apart.  For instance, large firm stocks have often experienced a loss around once every three years.  For some including me, market volatility can be unsettling.  The price of a stock may be impacted by internal corporate problems, such as a defective product, or outside factors such as market or political developments. 

Inflation Risk:

A general increase in prices is referred to as inflation.  For investors who get a fixed rate of interest, inflation diminishes their purchasing power, which is a risk.  The main worry in investing in cash equivalents is that inflation would reduce returns.

Interest Rate Risk:

A bond's value may alter as interest rates fluctuate. The face value(When you purchase a stock at face value, this will be listed on the stock certificate as its original cost), of the bonds, plus interest, will be paid to the holder if they are held until maturity(the date when a bond's principal is repaid with interest). The bond's value could be more or lower than its face value if it is sold before it matures.  Newly issued bonds will be more tempting to investors when interest rates rise because they will pay a greater interest rate than older bonds.  You might need to sell an older bond at a discount if you want to sell it because it has a lower interest rate.

Example of how interest rate affects bonds: The rate of interest the bond issuer will pay on the face value of the bond expressed as a percentage. For example, a 5% coupon rate means that bondholders will receive 5% x $1,000 face value = $50 every year.


Liquidity Risk:

This refers to the possibility that investors won't be able to sell or acquire their securities when they want to due to a lack of a market for them. With the more complex investment products, this may be the case.  It may also be the case with products that charge a penalty for early withdrawal or liquidation such as a certificate of deposit (CD).


“Don’t be fearful of risks. Understand them, and manage and minimize them to an acceptable level.”
― Naved Abdali





Disclaimer:

I'm not a financial advisor. The content on this website is for educational purposes only and merely cites our own personal opinions. In order to make the best financial decision that suits your own needs, you must conduct your own research and seek the advice of a licensed financial advisor if necessary. Know that all investments involve some form of risk and there is no guarantee that you will be successful in making, saving, or investing money; nor is there any guarantee that you won't experience any loss when investing. Always remember to make smart decisions and do your own research!

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