What is Investment Risk and Why is it Important?
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Defining investment risk might sound simple – it’s the threat of losing money, right?
Well, while potential monetary loss forms the basis of risk, there’s more to the story. Because risk takes many forms in the field of investing, and there are a whole host of threats that are unique to different types of investments.
So, to fully understand the definition of investment risk, you need to consider a broad range of factors. In this guide, while we’re not offering you financial or investment advice, we will show you what investment risk is and why it’s important, before offering some tips on how to effectively minimize risk when investing. Remember, Glint isn’t an investment platform, so we’re able to remain completely neutral on the subject.
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What Is Investment Risk?
Investment risk isn’t just the threat of losing money. It encapsulates all the factors that can affect your return on investment – whether that’s market conditions, geopolitical events, changing legislation, economic performance, or even things like climate change and extreme weather.
To this end, the consequences of investment risk aren’t purely limited to losing money. From dwindling returns to watching investments fail to grow, the repercussions of investment risk can be detrimental, so it’s important to do everything you can to mitigate risk where possible (more on this later).
To further complicate the issue of investment risk; there’s a fine line between being too exposed to risk and too risk-averse.
Exposing yourself to risk can lead to loss and dwindling returns. But remember, investing is never without risk, so by not taking enough calculated risks, you could effectively weaken your position and potentially lose more money than you otherwise would have.
Getting investment risk right, then, is something of a balancing act. You need to take some risks to ensure you’re not losing out unnecessarily, while also being aware of your limitations and exposure to external forces.
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Why Is Investment Risk Important?
Understanding and accepting investment risk is important for several reasons, including:
Allows you to set your own risk parameters – knowing the risks you face as an investor puts you in a powerful position wherein you can set your own parameters and level of exposure to risk. For instance, if you’re happy to accept the calculated risk of losing money, you may seek high-risk, high-reward opportunities. If, however, you don’t want to lose any money, this will also dictate the investments available to you.
Demonstrates both sides of the investment coin– those new to investing may see some opportunities as overly risky, or even reckless. But with experience and a clearer understanding of investment risk, you can make calculated decisions and avoid allowing an aversion to risk stop you from taking on a project that could prove lucrative in the long run.
Shows you which investments may be most suitable for you – when you understand the different types of investment risk, you’ll be better placed to decide on the opportunities that are right for you. For example, typically high-risk investments like cryptocurrencies and commodities may be better suited to some types of investors than others due to the risks involved, while things like bonds and shares may be a good option for the more risk-averse.
What Are the Main Types of Investment Risk?
As an investor, there are two main risk types that you need to be aware of: systematic investment risks and unsystematic investment risks. We’ll cover what these are and their characteristics below.
What is Systematic Investment Risk?
Systematic investment risk generally covers threats affecting the broader economy and market. Often referred to as market risks, these are factors that disrupt economic performance and market conditions, and put the success and returns of individual investments in jeopardy.
Examples of systematic investment risk include geopolitical events, economic uncertainty, rising inflation, and socio-political activity. It can be difficult to avoid and mitigate systematic risk, since they affect the broader market and can directly affect a broad range of industries at any one time.
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What is Unsystematic Investment Risk?
Unsystematic investment risk is any threat faced by an individual industry, sector, or business. These kinds of risks don’t arise from broader market conditions but are instead prompted by industry-specific events and activity. In short, they’re anything that can affect a business’ ability to turn a profit and thus offer a return to its shareholders, including things like:
Regulatory changes or legal action
A change in management or senior personnel
Product recalls or errors
Bad PR and reputational damage
The emergence of new competitors within the market
Unsystematic investment risk can be damaging, with the potential for investors to lose everything should the outcome be particularly detrimental. However, there are ways to protect yourself against unsystematic investment risk, including asset portfolio diversification.
How Do You Minimize Risk When Investing?
While it’s impossible to remove investment risk altogether, there are plenty of things you can do to mitigate it and protect yourself from financial loss. Below, we offer a few essential tips on how to minimize investment risk.
Diversify your investment portfolio – as touched on above, one of the best ways to mitigate investment risk is to diversify your portfolio. The proverb “never put all your eggs in one basket” is perhaps the best way to sum up the benefit of diversification; it’s all about spreading the risk across multiple assets to minimize threats regardless of market conditions.
Invest in pooled funds – if you want to diversify your assets with minimal legwork, putting money in a pooled fund can be effective. Essentially, this is when you give a lump sum to a fund manager, who will spread it out across multiple assets to manage your desired level of risk and return.
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Invest globally – one way to mitigate systematic risk is to invest on an international scale. This means that your money won’t be so easily affected by economic disruption in a single country.
Assess your investments regularly – to make sure you’re always hitting the sweet spot between risk exposure and risk aversion, assess your portfolio regularly to see how your investments are performing. If things have slowed, you may consider that it could be time to look at new, potentially riskier options; if there’s trouble brewing in the wider economy, you may choose to dial things back.
At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.
While explaining Investment risk, we are giving you the information to help you make up your own mind. Glint does not offer any financial or investment advice and would not ever make a suggestion that you should enter into a situation that would put you or your money at risk. Your money is at risk with all investments.
To learn more, visit our homepage or give us a call at +44(0)203 915 8111.
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