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There are two kinds of Investment risk:
The first risk is referred to as Systematic Risk. Systematic risk influences a large number of investments across a broad spectrum. The financial crisis of 2008 is a good example. Practically, every asset was impacted adversely. This type of risk is almost impossible to protect against. In other words, like lightning strikes.
The second risk is referred as Unsystematic Risk, also known as "Specific Risk." This is the type of risk that impacts a smaller number of investments across a narrow spectrum
Many specific types of Unsystematic Risk exist in the world of investing which I have mentioned below:
- Market Risk
It is simply the normal fluctuations in the price of an investment. It is most apparent in stock-related investments. In this type of risk value of investment decreases, due to market forces.
- Credit Risk
This is also known as default risk. This occurs when a person or entity (private/government agency, etc.) is unable to pay what they owe on their debt. It can be either the principal or the interest.
- Interest Rate Risk
This refers to the risk when a change in interest rates affects the value of an asset or debt instrument. Typically, the risk applies to bonds in a more direct fashion than it does to stocks.
- Political Risk
This refers to the risk that occurs when the policies of a country change, especially if it happens randomly.
Key Takeaways
Risk cannot be avoided and needs to be understood.
Through proper planning and execution, you can mitigate risk and profit from it.
Your goal is to reduce risk and maximize rewards.
Even though the market rewards risk-taking that does not imply that just because an investment is high-risk, it will be high-reward. There will always be a tradeoff.
Review all your investments to make sure you understand what type of risks you have.
