How to Tackle Investment Risks

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What is risk?
Risk is the possibility that something unexpected could happen, even if we believe the outcome is predictable.

For example, when we cross the road, we assume that drivers will stop for us. They are likely trained and experienced, but there's always a chance that they are not—or that they get distracted and fail to stop in time. Despite crossing the road safely many times before, there remains a risk of an accident.

Similarly, if we regularly dine at a restaurant with a skilled and careful chef, the likelihood of food poisoning is low—but not zero. A single mishap in the kitchen could still cause an issue. No matter how much we plan or prepare, a small chance of an unexpected event always exists.

This principle applies to other areas of life, such as choosing a career or a life partner. We conduct research, rely on advice, and trust our instincts, yet there is no absolute guarantee that things will turn out as expected.

Risk in Investments
Just as in life, risk is present in financial decisions. The biggest risk from a personal finance perspective is failing to meet financial goals—both present and future. However, in investing, one of the most significant risks is inflation risk.

When we save money in a bank or invest in fixed deposits, we might believe it’s safe. However, inflation reduces the future value of money, meaning we may not be able to afford the same goods and services later. This erosion of purchasing power is a major investment risk.

Types of Investment Risks

1. Inflation Risk – The risk that rising prices will reduce the purchasing power of our money.

2. Interest Rate Risk – The risk that changes in interest rates will affect investments. Interest rates influence asset prices—when they fall, asset values tend to rise, and when they rise, asset values may decline.

3. Market Risk – The possibility that an entire market (such as the stock market) may decline due to economic factors.

4. Price Risk – The risk that the price of an individual asset may fluctuate unpredictably.

5. Liquidity Risk – The inability to sell an asset when needed due to a lack of buyers in the market.

6. Counterparty Risk – The risk that the other party in a transaction fails to fulfill their obligations.

7. Credit Risk – The risk that a company or entity issuing a bond may fail to make interest or principal payments.

8. Default Risk – The actual event of an issuer failing to repay its debt obligations.

While charts and theories often suggest that higher risk leads to higher returns, real-life investment outcomes are unpredictable. Risks don’t always translate into proportional rewards.

Managing Risk

Since risk cannot be entirely avoided, investors must learn how to manage it effectively. There are four main ways to deal with risk:

1. Avoidance – Completely avoiding risk is often impossible. For instance, putting all money in "safe" assets like gold or fixed deposits still exposes investors to inflation risk.

2. Acceptance – Some risks, such as market fluctuations, must be accepted as part of investing. Keeping an emergency fund in fixed deposits or cash can help navigate downturns.

3. Mitigation – Risk can be reduced by thorough research, due diligence, and diversifying investments across asset classes (stocks, bonds, gold, real estate, etc.). This strategy, known as asset allocation, helps spread risk.

4. Transfer – Some risks can be transferred to others, such as through insurance or hedging strategies.

Final Thoughts

Investment risks are similar to the risks we face in everyday life. Understanding them allows us to make informed financial decisions rather than relying on blind faith. A good advisor will always explain risks clearly rather than claiming an investment is “risk-free.”

Most importantly, while historical performance can provide insights, it is not a foolproof predictor of future outcomes. Being mindful of risks, acknowledging uncertainty, and managing investments wisely is the key to long-term financial stability.