Hamilton Finance: Understanding Risk
Daniel Saikaley CA CFP
Investment Advisor, CIBC Wood Gundy
Risk is one of those four-letter words that people try to avoid, particularly when it comes to investing their hard-earned dollars. Because although risk does not necessarily mean that you're going to lose all your money, it's this image that often springs to mind when the subject is first broached.
Having said that, it's impossible to completely eliminate risk since all investments carry some degree of it. The key to being a successful investor is to determine the level of risk that you are prepared to tolerate, and then invest accordingly. But before doing this, you need to understand risk and the various forms in which it can appear.
Broadly speaking, risk is the possibility that the expected return on your investment may not be fully realized. This includes the possibility that you may lose some principal. However, there are in fact five categories of risk you need to consider when assessing an investment:
- Inflation Risk: The danger that rising prices will reduce the purchasing power and real rate of return on your investment over time.
- Interest Rate Risk: The possibility that a rise in interest rates may dictate a drop in the value of your investments. For example, rising rates can make dividend yields on current investments less attractive.
- Economic Risk: The danger that a downturn in the economy, or other significant economic event, will depress the value of your investments by reducing earnings capabilities.
- Market Risk: The possibility that events in the market itself may have an adverse effect on the value of your investments.
- Specific Risk: Relates more directly to the individual investment itself. It covers such elements as new technology making a certain firm's products obsolete, or greater competition reducing earning capabilities.
With a greater understanding of the various forms of risk, you'll be in a better position to find ways to help reduce risk.
Daniel Saikaley, CA CFP
CIBC Wood Gundy
50 O'Connor St., Suite 800
Ottawa ON K1P 6L2
613 783 4674
800 267 9345