At nVest Advisors, risk management is a primary focus when managing your long-term savings, and we work hard to get to know you and your goals so that we are adding on appropriate amounts of risk to meet your investment objectives in the time you have to reach them.
There are three major factors when it comes to understanding your risk tolerance: your overall psychological ability to remain focused on goals when your investments temporarily decline (this is called volatility tolerance or general risk tolerance), the amount of time you have from today until your financial goal must be met (this is often called the time horizon), and the current macroeconomic environment you will be investing into (different investments and asset classes respond in certain ways during upward-growing economies, but may behave very differently as things “cool off”). Because an economic cycle typically lasts 7-10 years, the broader economy must be taken into account in long-range investment planning.
Your unique risk tolerance then becomes the basis for constructing a strategy. It also lets us determine what has been realistic, historical investment returns for someone in your general risk category. This is important to understand because each type of investment and asset class carries a unique set of risks. Even cash, sitting in a safe somewhere, carries what is called inflation and monetary risk, at minimum. The correct way to create a portfolio is to create the right mix of investment risks, in the right proportions, to meet your goals, without adding even more risk than is necessary.
Want to know your Risk Tolerance? Take our FREE 15-question quiz today.
Investment risk refers to the possibility of losing money on an investment. Every investment comes with some level of risk, and understanding the different types of investment risk is crucial for making informed investment decisions. Here are eleven of the most common kinds of investment risk.
Market Risk
Market risk, also known as systematic risk, refers to the risk that the overall market will decline, causing all investments to lose value. Market risk is beyond the control of individual investors and is caused by events such as changes in economic conditions, political instability, and natural disasters. Even a diversified portfolio of stocks and bonds can be affected by market risk.
Credit Risk
Credit risk, also known as default risk, is the risk that an issuer of a bond or other fixed-income security will fail to make interest or principal payments on time, or at all. Credit risk can also apply to corporate bonds and is typically higher for lower-rated bonds that are issued by companies with weaker financials.
Inflation Risk
Inflation risk refers to the risk that the purchasing power of an investment will decline over time due to inflation. Inflation is the rate at which prices for goods and services increase over time. If the rate of inflation is higher than the rate of return on an investment, the investor’s purchasing power will be eroded, and the investment will lose value in real terms.
Interest Rate Risk
Interest rate risk is the risk that changes in interest rates will affect the value of an investment. As interest rates rise, bond prices generally fall, and as interest rates fall, bond prices generally rise. Therefore, investors who hold fixed-income securities face the risk of capital losses if interest rates rise.
Liquidity Risk
Liquidity risk refers to the risk that an investor will not be able to sell an investment quickly enough to prevent a loss. This risk is higher for investments that are not traded frequently or that are in markets with low trading volumes.
Currency Risk
Currency risk, also known as exchange rate risk, is the risk that the value of an investment will be affected by changes in exchange rates. For example, if an investor buys a foreign stock or bond denominated in a foreign currency, changes in the exchange rate between the investor’s home currency and the foreign currency can affect the value of the investment.
Political Risk
Political risk refers to the risk that political events or instability will affect the value of an investment. Political risk can arise from factors such as changes in government policies, nationalization of assets, and war or civil unrest.
Concentration Risk
Concentration risk refers to the risk of holding too many assets in one particular sector or asset class. For example, if an investor holds all of their assets in a single stock, the performance of that stock will have a significant impact on the overall value of the portfolio. Diversification can help reduce concentration risk.
Reinvestment Risk
Reinvestment risk refers to the risk that an investor will be unable to reinvest cash flows at the same rate of return as their original investment. This risk is particularly relevant for investors who hold fixed-income securities that pay interest or dividends.
Volatility Risk
Volatility risk refers to the risk that the price of an investment will fluctuate significantly over a short period. This risk is particularly relevant for investors who hold assets that are subject to significant price swings, such as stocks or commodities.
Event Risk
Event risk refers to the risk that a specific event will occur that will cause an investment to lose value. Event risk can be caused by a wide range of factors, such as natural disasters, terrorist attacks, or changes in government policies.
The Bottom Line
Knowing your risk tolerance, and then also knowing the different ways even relative “safe” investments can carry risk, is a vital part of constructing a serious, long-term portfolio strategy. At nVest Advisors, risk management is a crucial part of our process; so much so that we even offer free comprehensive financial planning to our investment clients, because knowing as much about your financial situation and goals makes the job of managing your assets that much easier. If we know what the money needs to do for your overall plan, huge numbers of investment options and styles can be automatically removed if they don’t have the inherent risk/return characteristics that your plan requires.
Want to know your Risk Tolerance? Take our FREE 15-question quiz today.
nVest Advisors specializes in helping working-age, professional families and small businesses start their financial journey, grow every step of the way, anticipate and correct setbacks, and celebrate with you when we reach the top together. Your success is all we care about, and helping you overcome the perils along the journey to financial freedom, including the times when you may be your own worst enemy, is how we spend our day. It’s genuinely a privilege to help families and small businesses who want tomorrow to be better than today.
Reach out to us for a totally free, totally no-risk portfolio checkup today if you’re concerned about where your finances sit for the coming recession, particularly if you are at or approaching retirement age. A review of your current risk in relation to your tolerance will be a key part of it. We’re delighted to offer you our thoughts. You can schedule that time with us below:
