Investment Risk Management: Understanding Types of Investment Risks (Part 1)

Hello!

I hope you are well.

Let's dedicate this series to Investment Risk Management.

Understanding and managing risk is crucial for any investor looking to build a resilient portfolio. In this first part, we will explore the various types of investment risks that investors face, laying the groundwork for effective risk management strategies in subsequent parts.

Why Investment Risk Management Matters

Risk management is about identifying, assessing, and prioritizing risks, followed by coordinated efforts to minimize, monitor, and control the probability or impact of unfortunate events. By understanding the different types of risks, investors can make more informed decisions and protect their investments from unexpected market movements.

Types of Investment Risks

1. Market Risk

• Definition: The risk of losses due to changes in the overall market conditions.
• Components:

2. Credit Risk

• Definition: The risk of loss arising from a borrower’s failure to repay a loan or meet contractual obligations.?
• Components:?

3. Liquidity Risk

• Definition: The risk that an investor may not be able to buy or sell investments quickly enough to prevent or minimize a loss.
• Components:?

4. Operational Risk

• Definition: The risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events.?
• Components:

5. Inflation Risk

• Definition: The risk that the purchasing power of an investment’s future cash flows will decline due to inflation.
• Components:

6. Political and Regulatory Risk

• Definition: The risk of loss due to changes in the political environment or regulatory landscape.?
• Components:

7. Concentration Risk

• Definition: The risk of loss from having too much exposure to a single investment, sector, or geographical area.?
• Components:

Why These Risks Matter

Understanding these risks is the first step towards managing them effectively. Different investments carry different risk profiles, and recognizing the type and level of risk associated with each can help investors diversify appropriately, hedge against potential losses, and make more informed investment choices.

Conclusion

Investment risk management starts with a solid understanding of the various types of risks that can impact your portfolio. By identifying and assessing these risks, investors can develop strategies to mitigate them and build a more resilient investment portfolio.

Stay tuned for Part 2, where we will discuss the tools and techniques used to assess and measure investment risk.

Interesting content I consumed in the past weeks:

[Podcast] Balance sheet recession of China by Jack Farley

[Article] Asking a Better Question by John P. Hussman

[Video] How to Think About Risk with Howard Marks

A picture worth a thousand words: