While there are several types of risks involved in investing, the ones investor should familiarize himself with include
Credit risk
This is the risk that a company will default on payment of the bond or debenture proceeds or a bank or financial institution will default on a deposit.
Liquidity risk
This is the risk of being saddled with an investment for lack of transactions in the market either due to quality or pricing issues. For instance, there might not be enough transactions in a particular stock due to lower number of tradable shares. Or there might not be many transactions in the real estate market as prices are sticky at higher levels making investors adopt a wait and watch stand.
Inflation risk
This is the risk that an investment will not generate desired returns due to higher level of prices. Higher inflation brings down, what is known as, real returns of the investment.
The individual must identify investments that are well-placed to negotiate the risks. For instance, take life insurance. An insurance plan that invests primarily in AAA rated paper nullifies credit risk to a large extent. This also takes care of liquidity risk as AAA rated paper is widely traded in the market. Of course, it might be too much to expect individuals to accurately interpret the risks associated with their life insurance plans. That is why it is a good idea to ask pointed questions to your insurance advisor or the company agent before investing in the plan.
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