When you invest, you incur risk — there’s no avoiding it. But the concept of “risk” may be more expansive than you realized. And by understanding the different types of investment risk and how these risks can be addressed, you can improve your skills as an investor.
The most common perception of investment risk is simply the risk of losing money. When you invest in stocks and stock-based vehicles, such as mutual funds, there are no guarantees that your principal — your initial investment amount — will be preserved. Generally speaking, if you hold stocks or mutual funds over a period of years, and even decades, you can reduce the likelihood of sustaining losses that could send your investments’ value to zero. Hopefully, the value of your investments will rise over time. And it’s worth noting that, since the Great Depression, U.S. stocks have averaged 9.59% annual returns, according to Morningstar Direct, an investment research service. However, past performance can’t guarantee future results.
In any case, this type of risk is real, and it’s a factor to consider when making your investment decisions. But you can’t avoid all risk by avoiding stocks and putting your money into other types of investments. Consider bonds, for example. When you purchase a bond, you typically receive regular interest payments and you get back your initial investment when the bond matures, provided the issuer doesn’t default. But if interest rates go up and you want to sell your bond before it matures, you’ll have to offer it at a “discount,” because no one will pay the full price for your bond when they can buy new ones at a higher rate.