The Warning 5 Investment Risks when Making Investment Decisions

Once you know how much money you need to meet your goals, you then have to think about where to invest it. To make that decision, you need to understand the different risk factors. Also, you should consider each investment’s potential for income and growth as well as its liquidity. You should evaluate the overall risk factor of making investment by examining five different components of risk: inflation risk, interest rate risk, business failure risk, financial market risk, and global company risk. Not only this will saving extra money, but the decision of investment is for long term investment only.

1. Inflation Risk

Inflation is a persistent economic condition that affects everyone. The loss of value to your money was a result of inflation, which is a general rise in prices that affects everybody. Investing your money can help you stay ahead of inflation. However, during periods of rapid inflation, the return from your investments might not keep up with the inflation rate. When that happens, you lose buying power, and your money will buy less.

You can calculate the effect of inflation investments. First, subtract your rate of interest from the inflation rate. This is your loss of buying power converted to a percentage. Then multiply that percentage by the original amount of your investment. The result is your loss of buying power in dollars and how much it would cost you to purchase the same investment today.

Some investments will protect you from inflation risk better than others. For example, over the period from 1926 - 2002, the compounded rate of return on common stocks adjusted for inflation was 7 %. Concurrently, U.S. Treasury bills (Tbills) had an inflation adjusted compounded rate of return of only 0.6 %. During that time, common stocks provided a better protection against inflation investment than did Tbills.

2. Interest Rate Risk

If you put money in an investment that gives you a fixed rate of return (stable rate), such as government or corporate bonds, the value of your investment will go down if interest rates go up. If you have to sell your bonds, you will get less than you originally paid.

To figure out the market price of a $1,000 bond if interest rates go up, divide one year of interest at a fixed rate of 8 % by the new higher interest rate of 10 %. If you hold onto the US Saving bond until maturity, you will get your full $1,000 back, but you will receive only 8 % annual interest. You should put more concern for interest rate risk, because it eat up your investment.

3. Business Failure Risk

This type of risk applies to common stock, preferred stock, and corporate bonds. When you buy stocks or corporate bonds, you are investing in a particular company. You are betting that the company will succeed. However, it could fail, especially if the company is managed poorly. If the company declares bankruptcy, your investment may become worthless. Your best protection is to do careful research on companies in which you might invest. Another good idea is to invest your money in more than one company.

4. Financial Market Risk

Sometimes the prices of stocks, bonds, mutual funds, and other investments go up or down because of the overall state of financial markets. The value of a stock may decrease, even though a company is financially healthy. Factors that affect financial market risk include social and political conditions. For example, the price of oil stocks may be affected by the political situation in the Middle East, where much of the world’s oil supply is produced.

5. Global Investment Risk

Today many investors are investing their money in stocks and bonds issued by companies in other countries. Because these types of investment risk, financial analysts advise small investors to invest in global mutual funds, instead of individual international stocks. Global mutual funds are offered by U.S. firms. These mutual funds specialize in companies that operate in another nation or region of the world. A mutual fund includes stocks or bonds from many companies and may offer more safety than one company’s stocks or bonds.