The Risks of Investments
No one can guarantee they can double their money. Any investment which promises to do this typically involves risky investments. Utilizing rating tools can be useful in helping assess and compare their respective risk profiles.
Diversification is an effective strategy for mitigating risk, by spreading investments across different assets, industries, asset classes and market capitalisations.
Liquidity Risk
Liquidity risk refers to an asset’s inability to sell quickly enough in order to meet cash needs, which may impact investments on the stock market or businesses as well as banks being unable to cover short-term debt obligations.
One key indicator of liquidity is the quick ratio, which measures cash, marketable securities and liquid receivables divided by current liabilities. A quick ratio greater than 1 indicates that a company has enough cash on hand to meet all its financial obligations.
Financial distress is signaled by low quick ratios. Other telltale signs include sharply rising interest rates or the rapid depreciation of an asset’s market price. As seen with the failure of numerous banks and financial institutions in 2007, liquidity crises can quickly lead to total collapse; inadequate balance sheet management contributes further. It is vital for investors, businesses and financial institutions alike to manage liquidity risks effectively so that warning signs can be quickly identified and responded to in order to avert disaster.
Horizon Risk
Horizon risk refers to the possibility that an investor’s time horizon for their investments may unexpectedly shorten, such as due to unexpected financial events like replacing roof or job loss that force you to sell investments intended for long-term holding at reduced prices and incur losses.
Investors with shorter investment horizons often face the threat of substantial financial loss due to short-term price fluctuations, including those saving for retirement. Stock investments could delay your ability to reach retirement on schedule and result in lower returns than you might have hoped for; but investing for longer can mitigate this risk; longer horizons tend to offer greater return potential that make these options more desirable than their shorter-term counterparts.
Longevity Risk
Longevity risk refers to the possibility that individuals will outlive their savings, investments, pensions and other sources of retirement income. This risk can arise due to rising cost of living due to an aging population putting pressure on government resources and social welfare systems, increasing demand for healthcare and services and impacting economies and labor markets.
Strategies to mitigate longevity risks can include longevity insurance, pension plans and retirement planning as well as financial products like life insurance or annuities that offer retirement drawdown strategies that mitigate longevity risk while providing income streams throughout an individual’s lifespan. Unfortunately, managing longevity risk presents several obstacles, including lack of reliable population data to model longevity rates accurately and behavioral biases that cause individuals to underestimate the chances of living longer than anticipated.
Foreign Investment Risk
As global economies evolve into a reality, investors need to evaluate both risks and opportunities associated with investing abroad. If a country’s credit rating declines significantly, investors could incur substantial investment losses as bond holders or currency fluctuation can make losses unrecoverable.
When investing in bonds denominated in foreign countries’ currencies, your return depends on their relative values against the U.S. dollar – also known as foreign-exchange risk or exchange-rate risk – which fluctuate with economic cycles and can seriously diminish returns. Fluctuations is something to keep an eye on to protect your returns as fluctuations could significantly eat into returns.
Companies exposed to foreign-exchange risks can incur severe financial loss without effective risk mitigation strategies in place. This phenomenon, known as transaction exposure, occurs when foreign subsidiaries maintain separate financial statements in their native currencies; translating those reports can create losses when translated to local currency for accounting purposes. Contingency risk also exists when bidding on projects abroad or negotiating contracts that contain contingent components.
