Five types of investment risk
Table of contents
Key takeaways
- All investments come with their own risk and reward characteristics.
- Understanding the relationship between risk and reward, and your comfort level with both, is a crucial part of building your investment portfolio.
- Common investment risks include inflation risk, market risk, credit risk, currency risk, and political risk.
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What is investment risk?
It’s a fundamental principle that to earn a higher return over time in your investments, you have to be comfortable taking on more risk in the short term. All investments – from cash and bonds to stocks and cryptocurrencies – come with their own risk and reward characteristics.
The three major asset categories have different risk/return characteristics:
- Stocks – historically, stocks have the highest short-term risk but the highest long-term returns
- Bonds – generally, bonds are less volatile than stocks, but tend to deliver more modest returns
- Cash and cash-equivalents (short-term GICs or term deposits, T-bills, money market instruments) – These are among the safest investments, but offer the lowest returns
Understanding the relationship between risk and reward, and your comfort level with both, is a crucial part of building your investment portfolio.
Five common investment risks
Inflation risk
This is the potential loss of your purchasing power if the value of your investments doesn’t keep pace with inflation (a rise in the price of consumer goods and services). It’s most relevant for cash, bonds, or other fixed income securities.
Market risk
The risk that your investments could lose value because of events or developments in the financial markets. Market risks tend to affect the entire market simultaneously, and include things like interest rate movements, currency exchange rates, economic growth, or recession.
Credit risk
This risk applies to bonds and other debt securities, and whether a company or government issuer could experience financial difficulties and fail to repay its interest or principal obligations. Bonds and their issuers are given credit ratings by rating agencies based on their creditworthiness.
Currency risk
Also known as “exchange-rate risk,” currency risk applies if your investment is in a foreign currency. As exchange rates fluctuate, it can reduce the value of your investment. For example, if the U.S. dollar weakens against the Canadian dollar, a U.S. stock held in your portfolio will have less value in Canadian dollars.
Political risk
Also known as “geopolitical” risk, it arises from changes in government, monetary and fiscal policy, or legislative bodies. Your investments could decline in value because of political instability, for example, or international policies that affect the supply and demand dynamics of various commodity prices, such as oil.
You can assess your own investment risks with Portfolio Score™ including credit, currency, and inflation risks. Expand your knowledge of risk exposure by comparing your portfolio’s performance against domestic and global benchmarks.
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The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This material is for informational and educational purposes, and it is not intended to provide specific advice including, without limitation, investment, financial, tax or similar matters. Information, figures, and charts are summarized for illustrative purposes only and are subject to change without notice. All investments are subject to risk, including the possible loss of principal.