Before investing, it’s good to know everything about the process. You probably know the rewards; that’s why you want to get involved in the first place. But there are plenty of risks involved in investing as well. You should make sure you know what you’re doing before you get yourself involved.
Here’s a list of certain risks when investing, so you can study them and know exactly what you’re getting into.
Interest Rate Risk
Image via Flickr by 401(K) 2013
According to investopedia.com, “Interest rate risk is the possibility that a fixed-rate debt instrument will decline in value as a result of a rise in interest rates. Whenever investors buy securities that offer a fixed rate of return, they’re exposing themselves to interest rate risk. This is true for bonds and also for preferred stocks.”
Investopedia also suggests a fantastic article, “Forces Behind Interest Rates” that gives you a deeper understanding of how much influence interest rates have on investment and what causes them to change over time. Once you understand these factors, you’ll want to get a grip on the other factors that influence interest rates. The goal of this understanding is to eventually get you to a point where you can predict interest rates. Luckily, there’s another great article that focuses just on that entitled, “Trying to Predict Interest Rates.” Hopefully you’ll have a better idea of how to anticipate interest rate movements after the read.
Reinvestment/Call Risk
When the interest rate in your investment environment starts to decline, bondholders have to face the difficult task of investing the proceeds. They have to invest the proceeds in bond issues equal or greater to the interest rates of the redeemed bonds. Because of this, they usually have to buy securities that won’t give them similar levels of income.
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They can combat this by taking on more credit or market risk and buying bonds with lower credit ratings, but that’s usually not appealing. As investopedia.com puts it, “It is the risk that falling interest rates will lead to a decline in cash flow from an investment when its principal and interest payments are reinvested at lower rates.”
Call risk, on the other hand, is specific to bond issues. It refers to the fact that a debt security can be called before it’s fully mature. It’s often involved with reinvestment risk because, as investopedia.com puts it again, “the bondholder must find an investment that provides the same level of income for equal risk.” This kind of risk appears the most when interest rates fall because companies usually try to save money by redeeming bond issues using higher coupons and then using issues with lower interest rates to replace them on the bond market.
Mortality Risk
The time to think about mortality risk is when you want to have investments in pensions. Also consider it when you want to invest in insurance contracts, annuities, or any other investment that has a long-term horizon. The best example of this is probably annuities. According to Forbes, “If your annuity payments or distributions to you continue only as long as you’re alive, you run the risk of dying before you receive enough of your benefit to make the premium payments and fees worthwhile. If your investment strategy focuses solely on the long-term, there is a chance that you will never live to enjoy the benefits.”
People usually say life is short, but mortality risk works with the opposite worry. You’ve planned your life out financially and expected to retire at a certain time, and therefore die at an approximate age. But, if you live longer than expected, you might actually just run out of money.
Since Forbes offers a great resource for this kind of information, you should read work by Ken Fisher – CEO Fisher Investments, Forbes Columnist and author. He’s written a ton on the subject and has a book published, “Super Stocks,” that can help you learn more about investing.
Basically, you want to make sure you know what you’re getting into before you dive in. Investing often serves as the biggest financial risk anybody can make in their lifetime. There are smart and and secure ways to do it, but nothing is ever completely foolproof.
3 Risks Involved With Investing is a post from: Young Finances Please check out the site at http://YoungFinances.com or connect on Facebook at YoungFinances. Thanks!
