Different Types of Risk

Market risk is that your investment cannot be eliminated through diversification. It comprises the risk factors common to all firms.

Liquidity risk. Liquidity is the degree to which an asset can be sold quickly and easily without loss in value. Property investment assets are relatively illiquid investments because they may take weeks to sell. If a quick sale is needed, a reduction in price is usually required. Shares are generally more liquid than property, but it can still be hard to sell quickly and without moving the price against you. If other investors and market makers see you coming with a lot of shares that are infrequently traded they may well drop the price. Smaller company shares tend to be most illiquid. There are medium-sized firms where the majority of shares are held by a family or a few close associates. Trading here can be thin and illiquid. Many stock market listed companies see only one trade per month.

Event risk. September 11 and the war in Iraq were events that had profound impacts on airline companies. Event risk is the risk of suffering a loss due to unforeseen events. It could be less dramatic than war, e.g. a merger, a loss of a major contract.

Political risk. Changes in government or government policies may affect investors. This is more usually the case in developing countries where confiscation or forced nationalisation could take away all value from an overseas share holding. Even limits on dividends can have an impact. Note that investors in UK listed companies conducting activities abroad can be affected by political events in other countries.

Exchange rate risk. It is possible to lose money on investments abroad simply because the foreign exchange rate moves against you even if the value of the shares (when valued in the overseas currency) remains constant. However, if you are diversified internationally you may be able to take a swings-and-roundabout attitude to this risk.

Market risk. Your investment could be affected by a general slide in the whole stock market.

Manager risk. Most fund managers (of ISAs, unit trusts, OEICs, investment trusts, pensions, etc.) do not consistently manage to beat the market index average. Given this fact, you might like to save on the high fees of active fund managers and either manage your own investments or go for low-fee tracker funds or exchange traded funds.

Inflation risk. If you select safe investments such as building society accounts or government bonds you may suffer from inflation risk. That is, what seems like a reasonable return when inflation is 2 per cent loses purchasing power if inflation rises in the future to, say, 10 per cent. Investors in government securities were very badly hit in the 1970s as inflation rose to over 20 per cent: they had fixed their safe returns at around 5-6 per cent. Index-linked gilts and variable-rate deposit accounts alleviate this problem.