At various phases of investment and for varied aims, various sorts of risk must be handled. The possibility of losing the money invested is referred to as investment risk. Let us understand and evaluate classification of investment risks and different types of investment risks involved as a part of personal financial planning and safety measures.
Evaluation probability of losses involved in investing is known was risks evaluation. Financial planning is always incomplete without risks calculation. Every investment carries some risk of loss, but the investor may be able to mitigate it by better understanding and dividing the risk.
Classification of Investment Risk
Before we understand different categories before understanding investment risk types. “Types of Investment Risks” are Classified into Three classification of investment risk.
- Loss of capital invested (Invested amount).
- Estimated / returns / rewards income loss.
- Loss due to money valuation due to growing inflation rate.
When you plan to invest in stocks or funds based on past performance or past returns, it’s obvious that there will be deviation between expected returns and actual returns. If difference is positive then it is good sign with extended gains whereas negative indicates loss due to risks. There are chances that you may get panic during negative situations.
You should understand that risk and returns are two sides of investment coin and you should be prepared for both. Such short term panic situations should not hamper your long term investment goals. Apart from that you should be clear that when evaluated past performance of any stock or funds all situations are taken into consideration. You should develop a strategy in such a way that you can minimize your risk when market crashes and this can be achieved by diversifying your investment.
Example of Investment Risk: Investing small part of your capital into fixed deposit or government bonds where returns are fixed and guaranteed irrespective of market conditions. By diversifying you can reduce your risk level.
Top 3 – Types of Investment Risk
There are various different types of investment risks when trading in stock market, forex market, currency market or derivative market. Let us understand some of the primary ways to minimise risks of your investment:
Risk Tolerance Capacity
Means how much risk you are ready to accept it. In other words, how much maximum risk you intend to take to sleep peacefully even during financial crisis. Risk tolerance is our capacity to accept potential risk. This would differ from one investor to another investor. Your risk taking capacity will keep on changing with change in external factors.
For example: age, income source, dependents, life expectancy, etc. One should have clear drafted plan about how you will manage rise and fall of your investments plans before you start investing in real time. It is highly recommended that you calculate Risk Tolerance Capacity before investment. This is one of the important types of investment risks minimisation methods.
Risk Tolerance Example
Risk tolerance is our maximum capacity of accepting loss above that you cannot afford to lose further. Let us observe with example: After a self assessment, you decide to invest into stocks with maximum loss of 5% on investment as a part of safety measures.
Maximum loss is defined as stop loss limit for your investment. Suppose you buy Infosys stock, one fine day it is 3% up, Next day market crashes with 6% down, This is a day where your stop limit will hit and square off your investment. After that market continues to fall and after few months when market situation improves and stock started to rise.
You can again plan to invest into Infosys stock with 5% as your stop loss limit. Since market conditions are improved it is more likely that you will be in profit. This is the simplest way to cut your losses and let profit runs.
Real Risk Capacity
To achieve financial goals sometime you intend to take little higher risk then your risk tolerance capacity. This risk level is actual bearable risk known as real risk. For example you can set risk tolerance limit to 7% and real risk tolerance limit to 10% which means that you are increasing your risk level to increase your risk to reward percentage
Real Risk Capacity Example
The married accountant (high risk tolerance and low risk capacity) can seek a more expensive school, which necessitates a higher rate of return on college money, meaning a larger risk. The attorney who only needs 7% returns to retire may set a greater retirement objective to boost risk capacity and match risk tolerance.
Investment Based on Investors Tolerance Capacity
Investors are classified as traditional, moderate or aggressive investors. Some of the general investor’s standards are followed while investing. For example: Traditional investors (Individual risk level: Minimal) should intend to invest only 20-30% of its investment capital into stocks.
Moderate investors (Individual risk level: Moderate) should balance 50-50% of its investment capital into stock and fixed income deposits where as Aggressive investor (Individual risk level: high) can invest 90-95% of its investment capital into stocks and he can use the stop loss limit to minimise the risk level.
Here we have understood about different types of investment risks and methods on how to trade safely. Investor’s heads on to purchase high return stocks without evaluating their risk and other factors which bring down their profits. Smart investors always evaluate right stock, right time to purchase stock and risk tolerance capacity before investing which assist them to maximize their profit levels.
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Basics of Investing for Beginners
- Chapter 1: What is Investment and its objectives?
- Chapter 2: Why is Investment important for Economic growth?
- Chapter 3: Ways to Invest your Money and Make Profit
- Chapter 4: Best Investment Opportunities for your Retirement Income
- Chapter 5: What are the Legal Matters you should know before Investing?
- Currently Reading: Different Types of Investment Risks Involved in Investing
- Chapter 7: When and How to Invest in Stocks?
- Chapter 8: How Positive Attitude can improve your Investing mindset?
- Chapter 9: Should you Borrow Money to Invest in Stock Markets or Funds
- Chapter 10: 5 Rules of Thumb - To be consider before making Investments
- Chapter 11: How to Calculate Stock Market Returns and Break Even Point?
- Chapter 12: How to Calculate Compound Interest and Simple Interest?
- Chapter 13: Rule of 72, 114 and 144 of Compounding Interest formula
- Chapter 14: What is the Difference between Trading, Investment and Speculation?
- Chapter 15: How to become a Smart Investor or a Successful Investor
- Chapter 16: Tutorial Quiz – Basics of Investing for Beginners Module
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