Understanding the risks of investing

What is investment risk? 

Investment risk is the possibility that your investment will fall in value.

Investing is by its nature risky – where the goal is to make more money, but there’s never a guarantee this will happen. Even the smallest investments on ‘safe’ stocks carry some risk.

Before investing, you need to understand there are different levels of risk.

Every level suits a particular investment style. For instance, high level risk exists in volatile markets, whereas low level risk can be found in long term government bonds.

Do all assets have the same risk levels? 

Not all assets carry the same level of risk. Some things like shares and property are riskier because their value can go up and down a lot. Other things like putting your money in a savings account is far less risky as your money will broadly keep its value, although even here, inflation will erode the purchasing power of cash.

Find out more about low-risk investing, or high risk investing.

Types of investment risk 

Market risk 

Market risk is the possibility you'll lose money on investments because of changes in market conditions. 

Market risk comes from economic trends, political events, interest rates and investor sentiment.

When the market goes down, so does the value of investments. Equally when the market rises, investments tend to rise as well.

Market risk is common to all investors and is hard to predict and control.

Interest rate risk 

Interest rate risk is the risk that the value of your investments will reduce due to shifts in interest rates. When interest rates rise, the value of bonds and other fixed-income investments tend to go down - this is because newer bonds will offer higher rates. 

When interest rates go down, the value of those bonds will rise - this is because their interest rate is higher than newly released bonds.

Inflation risk 

Inflation is the risk that the value of your money will reduce over time because the prices of goods and services go up.

Essentially, if inflation is higher than your return on investment then your money won't be worth as much in the future as it is now.

Credit risk 

Credit risk is the risk a borrower might not be able to repay money they've borrowed. 

When you lend money or invest in bonds, you're taking on credit risk. If the borrower can't pay you back then you could lose some or all the money you lent them. So credit risk is the possibility you won't get back the money you're owed.

Liquidity risk 

Liquidity risk happens when you might struggle to sell something quickly, and won't get the price you want.

If you are holding investments like property or certain stocks (especially on the AIM market), it can be hard to sell them fast without losing value. So liquidity risk is the difficulty you might find in turning investments into cash without taking a loss.

Exchange rate risk 

Exchange rate risk is the risk your money will lose value because of changes in exchange rates. If you invest in a company abroad using foreign currency, then your return on investment will be affected by exchange rates.

Other types of risk 

Political risk is when your investments could suffer from political decisions, events or wars. Changes in government policies, regulations and geopolitical tensions all impact investment return.

Systemic risk is a risk that affects an entire financial system (as opposed to a single company). A financial crisis or a market crash would be a systemic risk.

Reinvestment risk happens when you might not receive the same rate of return from reinvestments. This risk can affect bonds or fixed-income investments when interest rates change.

Volatility risk is the risk of a sudden change in a stock price. High volatility causes greater changes in investment value.

Event risk is the risk that an unexpected event will affect the value of an investment. This could be something like a natural disaster, a war or a rogue billionaire CEO buying a media outlet.

Model risk is when the models used to make investment decisions are wrong. 

Cybersecurity risk is the risk that investments are exposed to cyberattacks or data breaches.

Managing your investment risk 

Managing investment risk means reducing your losses while getting value for money.

• Diversifying is important. Investing across different industries, asset classes and regions reduces the impact of any single risk.
• Reviewing your portfolio regularly helps you adapt to changing market conditions.
• Set a clear investment goal and manage your risk tolerance to ensure your strategy stays on track.
• Stay up to date with market trends, economic news and global events. This will help anticipate potential risks.

Risk management is about being proactive. You need to balance your returns with the level of risk you're comfortable taking.

Read more: How to manage your investment risk