Investment Risk Isn’t Just “What If I Lose?”
Investing can be intimidating, and risk is usually what makes it seem that way. And yes—you should definitely consider risk, but it is more than just a fear of losing money; it involves various factors that can affect your money in different ways. Once you understand what kind of risk you’re facing, investing might feel digestible.
Risk Comes in Two Buckets
Most investment risks fall into two categories: systematic and unsystematic. Systematic risk is a type of risk that can affect almost everyone in the market at the same time. Unsystematic risk is specific to a particular company or investment, and it is the type you can often reduce by diversifying your portfolio.
Systematic Risk: Risks You Can’t Fully Avoid
Systematic risk is “non-diversifiable" risk that you can't completely avoid, even with great investment selection. A simple way to remember common types of systematic risk is PRIME.
Purchasing Power Risk: Inflation causes your dollars to buy less in the future, even if your money is technically “growing.”
Reinvestment Risk: If interest rates decrease, the interest or dividends you earn might not be able to be reinvested at the same rate as before.
Interest Rate Risk: When interest rates rise, some investments, like bonds, can decrease in value, and vice versa; when rates fall, securities can increase in value.
Market Risk: Sometimes prices move together simply because investors react as a group (like a herd reacting to good news, bad news, fear, excitement).
Exchange Rate Risk: If you invest internationally, currency fluctuations can impact your returns when converting money back to your home currency (Mayo, 2021).
Unsystematic Risk: Risk You Can Reduce
Unsystematic risk, for example, can be linked to an individual company's, industry's, or investment's specific situation. This includes events like a company losing a major client or contract, a failing product, controversy, or poor financial decisions. The good news: this type of risk can often be reduced through diversification, which involves not putting all your money in one place.
Practical Example
Imagine you invest everything except your emergency fund in one company you really like. Then, unfortunately, that company has a bad year: sales decline, layoffs happen, and the stock drops 40%.
Because this is nearly all of your money, your entire portfolio (dare we say, your net worth) suffers a blow. But if you had spread those funds across multiple companies or invested in funds that hold many investments, a bad year for one company, while painful, might have been less likely to ruin your entire investment plan.
What’s the Point of Knowing This?
Understand that risk comes from different sources; not every market dip means an investment mistake or that you “did investing wrong.” Some risk is simply part of being in the market. You can't eliminate risk entirely, so it’s crucial to know what you can control—like diversification and how much risk you take—and what you can’t—like inflation or overall market swings.
Conclusion
Risk isn’t just, “but I might lose money?” It’s “what could affect my money today and in the future, and do I understand it?” When you learn the difference between market-wide risk and investment-specific risk, you can build a strategy that feels calmer, smarter, and more realistic.
Disclaimer: Creek & Lyells Financial Literacy Foundation does not provide financial services, nor does it recommend or advise visitors to open accounts or buy or sell securities. All content on this blog is for educational purposes only. While we strive to provide accurate, relevant, and well-vetted information, visitors should consult a licensed financial professional and carefully evaluate the risks of any financial decision before taking action.