It’s important for investors to understand that there are always risk factors involved with any type of investment. Understanding how these risks impacts our investments will help all Canadians make better investment choices.
Inflation Risk: Inflation erodes the purchasing power of your money each year as the prices of goods and services continue to rise. This is the reason why a favorite candy bar that cost $2 when you were a kid now costs $4 or more today. It also has a very significant impact on your investments. If your investments don’t grow at a higher rate than inflation over time, they will actually be worth less in the future in terms of their net purchasing power. Another way to understand inflation is, an average wage earners pay adjusted for inflation has not increased significantly since the 60s!
Company Risk or Market Risk: Purchasing shares, otherwise known as stocks or equity in companies, comes with some risk. Shares could decline in value based on a company’s poor performance, bad news coverage, etc. In the worst-case scenario, a company could go out of business, rendering their shares worthless. Exposure to this risk can be heightened if you purchase individual shares or stocks, or Exchange Traded Funds (ETFs) as there is little or no diversification in doing this!
Interest Rate Risk: Certain investments are sensitive to interest rates, especially fixed income investments. Generally, when interest rates fall, fixed income investments such as bonds increase in value. Conversely, when interest rates increase, fixed income investments decrease in value. For savings accounts and GICs, the interest rate offered is tied to the Bank of Canada rate which is currently at historic lows. So savings accounts at 1% interest and five year GICs around 2.5 %, while safe, are not keeping up with inflation and are losing future purchasing value as a result!
Credit Risk: Both companies and governments may suffer adverse changes in their financial condition which may lower the credit rating on the bonds they have issued, which in turn lowers the value of their bonds.
Liquidity Risk: Liquidity risk is the ability to sell an investment in a timely manner for it’s fair market value. For example, if someone had only 24 hours to sell their home, they would likely have to settle for something far less than its fair market value. That is liquidity risk.
Investment Time Line Risk: An investor needing to cash in his funds in a year or less compared to 30 or more years has to be much more cautious as to the type of investment he chooses especially regarding volatility.
Every investor has a different comfort level with the risk they can stand relating their money. If you’re looking for more information on investment risk and what suits you, seek out a trusted financial professional to review the various investment options that are right for you.
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