Recognize Risk in All Its Forms — Then Learn to Manage It

Stock market conditions in recent years have been an eye-opener for many investors. Whether the market is going up or down, it’s more important than ever to educate yourself about risk so you’re better prepared to cope with it.

Here’s an overview of the some different types of investment risk you may encounter as an investor.

Market risk — This is the possibility that the value of a security will move in step with the overall market.

Inflation risk — This is the risk that an investment’s return won’t keep pace with the rate of inflation. More conservative investments may be subject to higher levels of inflation risk. To determine whether an investment is staying ahead of inflation, subtract the annual inflation rate from its annual return.

Interest rate risk — When interest rates go up, bond prices go down and vice versa. This may not be a concern to investors who buy bonds and hold them until maturity.

Credit risk — This is the risk that a bond issuer won’t be able to pay interest due or repay principal. Bonds with lower credit ratings have higher credit risk, but may also yield higher returns.

Currency risk — Changing currency values can impact international investments. If the value of the dollar decreases, for example, it may increase the value of foreign investments.

Liquidity risk — The easier it is to sell an investment, the lower the liquidity risk. With more illiquid assets — real estate, for example — you may receive a lower price than desired if you need to sell quickly.

A Helping Hand
Fortunately, there are a number of tools that can help you to gauge risk. Here are two that measure market risk.

Beta weighs a security’s volatility in relation to the market as represented by a benchmark, such as the S&P 500. The “beta” of the benchmark is equal to 1.0. So an investment with a beta higher than 1.0 is more volatile than its market index and one with a beta lower than 1.0 is less volatile.

Standard deviation measures the amount by which an investment’s returns — over the past year, for example — have varied from its long-term average. The higher the standard deviation, the more an investment’s returns have diverged from the average. The potential result? More volatility.

Risk and risk measurements can be complex. Contact a qualified financial professional to find out how they apply to your portfolio.

©2004 Standard & Poor’s Financial Communications. All rights reserved.

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