Investment, Risks Go Hand in Hand

Investing is now no longer about making money. It’s about managing money — in good times and bad. The US stock market crash of 1987 and the late 1990’s showed how quickly the markets can now turn, and why we need to show a new appreciation for risk. So when you invest, you must pay attention to risk. To learn how to do that, keep reading. Never choose investments merely because you think they will be profitable.

Learn What “Risk” Really Means
In the world of investments, there are many types of risk, and although they differ from investment to investment, they all manifest themselves in the same way: Risk causes investment values to fluctuate. Thus, investment risk is best discussed in terms of volatility: If you invest one dollar today, how much might that dollar change in value? Under what circumstances would that change occur? These are the questions that volatility raises. The answers are based on the premise that all investments are volatile; there is no such thing as a risk-free investment. Some investments are more sensitive to certain risks than others, and some risks are more likely or more devastating if incurred than others. Therefore, some investments are more volatile than others. The interesting thing about risk is that it works both ways: Investments that have fallen victim to one or more risks can enjoy substantial upside volatility as they put their problems behind them; that is how investment values are able to increase. Risk, then, is not bad; it merely exists. Without risk, investments could not exist. In many ways, risk is like water to a plant: Too little and they fail to grow, while too much could drown them. To help you put it all in perspective, let’s first examine the major types of risk :

Default risk
The risk that an investment will become worthless.
UPSIDE:
Investments that have defaulted often recover, as did Chrysler. As the investment recovers, its value returns to previous levels, rewarding those who invested while prices were low. Investors who engage in this type of activity are called “bottom-fishers”.
Credit risk
The risk that an investment’s financial stability might decline; those that suffer credit risk might ultimately default. The stronger an investment’s financial stability, the more valuable it is (an AAA-rated investment is about 25% more valuable than a B-rated investment). However, the stronger an investment’s financial stability, the greater its potential losses from credit risk.
UPSIDE
Low-rated or previously downgraded investments could be upgraded, resulting in an increase in value.
Tax risk
The risk that investment profits will be subject to taxes, such as the income tax, capital gains tax, and/or estate taxes. For an investor in the 28% income tax bracket, for example, an investment whose profits are not subject to income taxes is automatically 28% more valuable than an investment whose profits are subject to that tax.
DOWNSIDE OF TAX-ADVANTAGED INVESTMENTS:
Investments that are free from taxes typically pay proportionately fewer profits than taxable investments. Furthermore, changes in the law could eliminate the tax advantages that investors were promised or are expecting.
UPSIDE:
None
Inflation risk
The risk that an investment’s income and principal, when received in the future, will have a reduced purchasing power due to an increase in the cost of living.
UPSIDE:
Deflation might occur, reducing future prices instead of raising them. Cellular telephones are much less expensive today than 15 years ago, as are VCR’s and many other products.
Interest rate risk
The risk that interest rates will rise. As rates rise, the value of bonds fall. Interest rate risk affects long-term bonds more dramatically than short-term bonds. For example, a 1% increase in interest rates causes a 10% decrease in 30-year bonds, but only a 4% drop for bonds maturing in five years.
UPSIDE
If rates fall, bond values rise. Because interest rates are constantly changing, interest rate risk is one of the most important of all risks, and a leading cause of both speculation and losses.
Currency risk
The risk that foreign currency exchange rates would rise. If that happens, investments you have in companies operating in that country would fall in value. For example, for a Trinidadian who invests in Japanese stocks, a 20% rise in the yen would produce a 20% drop in the value of the investments, in TT dollar terms. Investments that suffer from currency risk usually also face political risk.
Political risk
The risk that a foreign nation might go to war, or socialize private industry. Either could destroy your investments.
UPSIDE:
As with interest rate risk, currency and political risks are double-edged swords: improvements can boost the value of your overseas investments.
Market risk
The most commonly referred to of all risks, market risk is reflected in the daily price changes of stocks and bonds. Thousands of factors cause market risk.
UPSIDE:
Market risks, or rather investor’s changes in perception about market risk, allow investments to rise as well as fall.
Event risk
The risk that something both unexpected and beyond the control of management will cause an investment’s value to decline. Example. The discovery, after decades of use, that asbestos causes cancer. The news led to the failure of Johns-Manville, which manufactured the insulation product.

UPSIDE:
None-not because unexpected good things can’t happen, but because such surprises are, well, unexpected, and therefore unanticipatable. Most good news, such as a drug company’s accidental discovery of a cure for some major illness, certainly would increase the price of the company’s stock, but such a discovery is within the nature of that company’s business and therefore does not meet the definition of event risk. Such events more properly would be considered market risk.
Prepayment risk
The risk that your investment principal will be returned sooner than you anticipated, particularly if the investment was unusually profitable. Investors in Government of Trinidad and Tobago Bonds have been experiencing this within recent times as the Government attempts to refinance its debt at a lower rate, given a downward slide in interest rates.
UPSIDE:
None. Be thankful that you got your money at all.
Extension risk
The opposite of prepayment risk, meaning that your investment principal might not be returned as soon as you expected. Experienced by investors who placed their monies in Finance Companies in the middle 1980’s, at that time they were not under the full supervision of the Central Bank.
UPSIDE:
None.
Opportunity risk
 The risk that, by having your money invested in one place, you missed the opportunity to invest elsewhere for higher returns.
UPSIDE: The investment you have might well be better than the alternatives you missed. (Donald Trump once said, “Some of my best investments are the ones I didn’t make.”)
With this list of risks in mind, let’s explore their relationship to - and impact on - a variety of common investments.

DIAGRAM GOES HERE :

Low means the investment’s design severely limits opportunities for profit.
Moderate suggests that the investment generally earns more competitive returns, but upside reward is still somewhat limited.
High indicates that the investment has unlimited profit potential
R denotes major risk          r denotes minor risk

Be aware that merely being able to earn an unlimited return is in no way meant to suggest that a given investment ever has achieved substantial profits, or that it will ever again achieve substantial profits. Many also could argue that grouping so many investments as “High” unfairly - and unrealistically - suggests that they share an equal probability of achieving similar levels of success. That would be an incorrect and unintended conclusion, and such is not the intent of this chart; the “relative Profit Potential” column merely shows what is possible, not what is necessarily likely. Keep this important disclaimer in mind. With this information, choose your investments.