Here at Wealthface, we understand the importance of transparency and risk assessment. In these pages, you’ll find a full summary of the risks associated with investing. Please keep in mind that this is not an exhaustive list, but rather an outline of the factors which might affect your investments’ value.
Equity may be exposed to a high level of risk due to the rise and fall of prices in a short period. It could arise due to the conditions of the companies that issue them or general stock or economic situations.
Inflation risks are the risks involving the decline of the purchasing power possessed by any savings due to prices rising across the board.
Fixed-income security is a promise to pay interest and repay a specific sum at a later date. Credit risk, therefore, is the possibility that the promise made may not be honored. Credit rating agencies provide investors with a suggestion of the credit risk level represented by an issuer. Companies with high credit ratings represent a lower risk, whereas low credit ratings imply a greater credit risk, which should be kept in mind.
Investors looking to take advantage of volatility management are often interested in strategies based on short selling. Volatile or declining markets often present these kinds of strategies, but short selling securities do involve certain risks as an assurance of a sufficient decline in value in the period in which the lacking of short-selling takes place. As a result, there is no guarantee that the investor's interest can be offset for profits to be made. Short sold securities can then increase in value. The investor may find it difficult to repurchase and return the borrowed securities. The borrowing agencies (from whom the securities have been borrowed) may also find themselves in bankruptcy, leading investors to lose collateral unexpectedly.
Investing in securities priced in foreign currencies involves, by its nature, a foreign currency risk. These securities can lose their value when the currency of your country of residence rises against the foreign currency. Sometimes foreign governments impose currency exchange restrictions, limiting one’s ability to buy and sell some foreign investments. It can lead to a reduction in the value of foreign securities held by investors overseas.
Foreign investments sometimes involve additional risks, which arise from many different situations. The most common risks come about as a result of financial markets in other countries being less liquid and foreign companies perhaps being less regulated and subject to lower accounting and financial reporting standards. In some countries, a workable legal system related to the stock market may be lacking severely. Overseas investments are also affected by social, political, or economic instability, and they can also be subject to restrictions imposed by the country's government.
Liquidity refers to the speed and ease at which assets can be dealt with, sold, and made into cash. Most securities can be sold swiftly, and at a reasonable price. However, volatility in the market can lead to a drop in liquidity, meaning it isn’t so simple to sell quickly and without complications. Some securities become illiquid due to legal restrictions or the nature of the investment in question. Difficulties in selling securities can result in a smaller return or even a loss.
It’s a fact that not all investors are suited to the use of leverage. Using money that has been borrowed to finance the purchase of securities involves a high level of risk than purchases made with cash only. Should investors borrow money to purchase securities, the investor has a responsibility to repay the loan and pay the necessary interest – even if the securities decline in value.
Derivatives are investments whose value is derived from how other investments perform or moving interest rates, exchange rates, or market indices. The advisor may recommend derivatives to offset losses that other portfolio investments may suffer due to changes in stock prices, interest, exchange rates, or commodity prices. This process is called ‘hedging.
Common risks associated with investing in derivatives and hedging include:
- A lack of guarantee that the derivative will be bought or sold at the optimal moment to make a profit or avoid a loss being suffered. Alongside this, there’s no guarantee that the other party will honor their contractual obligations. Should the other party become bankrupted, the deposits or pledged assets of the investor may be lost.
- Hedging strategies are not guaranteed to work consistently, due to certain elements determining the value of the derivative being subject to changes which may go against the hedge’s intent.
- Hedging may not necessarily offset a drop in a security’s value, and hedging can even prevent portfolios from making gains that would have occurred were no action taken at all.
- It might be impossible to create an effective hedge against an anticipated market change, due to the fact that most other investors will also be expecting the same change.
Exchange-traded funds (“ETFs”) are securities that can be bought and sold just like common stocks:
- An ETF may not effectively track the market index or segment that underpins the investment’s objectives.
- ETFs may not be managed actively. Any ETFs which come under this category would not necessarily sell a security, primarily because the security’s issuer may have experienced some financial trouble. As a result, the ETF performance may end up being worse than the performance of a similar ETF managed differently.
- Some ETFs employ leverage, which may end up increasing the risk of a market segment or a particular index.
- The market price of a certain ETF unit may trade at a reduced or discounted value to its net asset value.
- An ETF unit’s active trading market may not develop and may not be maintained.
- A lack of guarantees that the requirements of the necessary exchange for maintaining the listing of an ETF will be continually or successfully met.