Understanding Risk

All types of investment, whether they be stocks, mutual funds, bonds, or any other form, come with risks just as they come with opportunities for financial growth.

Overall, investment risks can be classified as systematic or unsystematic. Systematic risks are those entailed by various political, economic, or policy factors affecting investment markets at large. These factors can include general changes in the economy, inflation, taxation, socio-political factors (i.e., wars), exchange rate fluctuations, and monetary policies.

Unsystematic risks, on the other hand, are those that are not related to the general volatility of the investment market. These factors are usually involve company-specific: leadership and management decisions, technological changes, competition, and employee relations.

Aside from these general classifications, risks can also come in three basic types.

Business risk is the possibility of losing securities value due to company mismanagement, business competition, and financial bankruptcy. Companies in certain industries are usually inclined to have higher business risk levels. Among these industries are those related to steel and to various means of transportation such as airlines and railroads.

Business risk is best managed through franchise value, which allows companies to increase prices to adjust to higher taxes or increased company operation costs such as those for labor, materials, and equipment.

Valuation risk, on the other hand, concerns prospects for future financial growth. In investing, one must make sure that the investment price is worth it, yielding high earnings in due course.

Last, force of sale risk could lead to forced selling of shares due to wrong decisions and faulty anticipation of investment outcome.

LESSON: Since risks cannot be avoided in investments, the best way to deal with them is to engage in effective risk management plans.