Investment Management: Knowing The Risks

Presented by Trevor Kurth, CFP®

History has shown that successful investing requires discipline and patience. When emotions and investment risks run high, it can be easy to lose focus on your investment strategy. To help you overcome these challenges, here are some important items to keep in mind:

Do You Know the Risks?

Investors need to remember that markets can be turbulent and that preparing for potential declines is essential. There can be a strong temptation to pull out of markets when they become volatile. However, instead of acting on this temptation, it may be smarter to adjust your investment approach. By remaining flexible, you might be able to take advantage of opportunities while managing risks.

• Company-specific risk, which is diversifiable or unsystematic risk. This type of risk does not affect all securities and can be reduced through diversification.
  
  
• Market risk, also known as systematic, economic, or undiversifiable risk. Market risk affects all securities in a market, and cannot be eliminated through diversification.
  
  Types of market risk include:
  
  
  • Interest rate risk is the potential for investment losses resulting from a change in interest rates. If interest rates rise, for instance, the value of a bond or other fixed-income investment will decline.
    
    
  • Currency risk is sometimes referred to as “exchange rate risk” and arises from the change in the price of one currency in relation to another. Investors or companies that have assets or business operations across national borders are exposed to currency risks that may create unpredictable profits and losses.
    
    
  • Reinvestment rate risk: Some investments provide the investor with periodic cash flow, or yield. Stocks can provide cash flow in the form of dividends, and bondholders receive regular interest payments. An investor may decide to spend these cash receipts or reinvest them. An investor who chooses to reinvest the cash receipts may not be able to earn the same rate of return as they did on the original investment. For example, if an investor holds a bond that makes a 4% coupon payment, but interest rates have fallen since that bond was issued, that investor may only be able to buy a similar bond with a 3% coupon.²
    
    
  • Political risk is the risk an investment's returns could suffer as a result of political changes or instability in a country. Instability affecting investment returns could stem from a change in government, legislative bodies, other foreign policymakers or military control. 

A Risky Balance

A variety of factors may cause one to act more cautiously than normal, including ongoing global uncertainties and fears about the overall economy. This can lead to investors flocking to low-risk investments despite misalignment with their goals. Remember, while minimizing risk can feel like a safe move, you could miss out on opportunities as a result.

Another mistake can be creating a portfolio that doesn’t reflect your overall risk tolerance. When building a portfolio, the objective is to take on the amount of risk that aligns with your goals and time horizon. This is often accomplished through a diversified allocation of assets that may help manage your portfolio’s risk. It’s important to remember that asset allocation is an approach to help manage investment risk. It offers no guaranteed protection against investment loss.

Leave Emotion at the Door

When markets swing, emotional decision making can wreak havoc on the most carefully designed investment strategies.

Fear and greed can drive anyone’s financial decisions. Fear can cause us to abandon an investment strategy when the outcome is not what we want, while greed can cause us to chase investment fads and assume too much risk. As you invest, you can support your strategy by attempting to manage these emotion-based decisions.¹

An investment professional may be able to help when emotions enter the decision-making process. When markets decline, they can answer questions, provide reassurance, and show you the opportunities that volatile markets may provide.