It’s risky not to understand risk
Provided by RBC Wealth Management
and Dave Dupont
What does investment risk mean to you? To many people, it’s simply the risk of losing principal when the value of their investments drop. And to help lower this risk, some investors reduce their holdings in those investments, such as stocks, whose value will constantly fluctuate. But is this a good idea?
Actually, such a move can have negative consequences. For one thing, stocks provide more long-term growth potential than other financial assets — including bonds, Treasury bills and certificates of deposit (CDs) — and you will certainly need this type of growth to help achieve your long-term goals, such as a comfortable retirement. But just as importantly, even if you minimized your exposure to stocks and focused on other investments, you’d discover that all investments carry some type of risk.
Some risks include:
• Purchasing power risk. In recent years, we’ve experienced relatively mild inflation. But over time, even a low inflation rate can erode the value of your savings. If you overload your portfolio with fixed-rate investments — such as CDs and money market accounts — with returns that may not keep up with inflation, you may incur purchasing-power risk.
• Liquidity risk. If you ever need to “cash out” some of your stocks and bonds, you won’t have much trouble selling them. But other types of investments are more illiquid. For example, if you buy shares in a limited partnership that invests in real estate, oil and gas exploration, equipment leasing or other activities, you could eventually make a profit, but you still might have trouble selling your shares at a specific time.
• Credit risk. If you want to receive a higher interest rate than that offered by “investment-grade” bonds, you might decide to purchase a bond that receives a lower grade from one of the independent rating agencies. In exchange for the higher interest rate, though, you take on more credit risk — the risk that the bond issuer may default, possibly depriving you of the return of your principal. So-called “junk bonds” typically offer the highest interest rates and carry the highest degree of credit risk.
• Currency risk. When you invest in non-U.S. companies, or in bonds issued by foreign governments, you might experience currency risk, which means that changes in the value of the U.S. dollar, relative to foreign currencies, could harm the value of your investments.
By being aware of the different types of risks associated with various investments, you can avoid unpleasant surprises.
This article is provided by Dave Dupont, a Financial Advisor at RBC Wealth Management. RBC Wealth Management does not endorse this organization or publication.
RBC Wealth Management, a division of RBC Capital Markets LLC, Member NYSE/FINRA/SIPC