Dig Deep when Searching for Investment Risk

Understanding all of the different types of investment risk is essential if you are going to be a successful investor. When you are researching a company, you need to do your best to identify all of the different areas in which risk could present itself. Here are a few things to consider about investment risk.

Too Much Debt

When you are looking at an individual company, there is a good chance that you are going to look at that company's financial statements. Many investors use valuation multiples in order to come up with ratios that help them compare companies. When you are looking at a company, you need to see how much debt it has in relation to the amount of revenue that it brings in. If a company has a high debt ratio, it is at an increased position of risk. The company could go into default, and you could potentially lose your investment.

Sector Risk

In addition to looking at the individual company, you also need to look at the sector in which it is located. Many investors get interested in a certain sector of the market. Because of this, they invest a large portion of their money into that particular sector. In order to lower your risk, you should invest your money into several different sectors. By doing this, you are going to be able to lower your portfolio's overall risk. If you put too much money into one particular sector, that sector could perform poorly. By spreading out your money, you are going to be able to withstand poor performances by sectors.

Interest Rate Risk

Another type of risk that you will have to be aware of is interest rate risk. This applies to fixed income securities such as corporate bonds. When you invest in a bond, the issuer is going to pay you a fixed amount of interest over the life of it. When you invest in this type of security, it is going to be inversely related to market interest rates. If the interest rates in the market increase, the value of your bond is going to decline because it is paying a lower interest rate.

Market Risk

Regardless of how good of a job you do researching your companies, your investment is still going to be subject to market risk. If the entire economy performs poorly, the stock market as a whole is going to go down in value. When this happens, there is not much that you can do with each investment. Having your money diversified into several different investments is going to help your odds in this situation. However, you have to live with a certain amount of market risk regardless of how well you diversify your portfolio. If you are willing to diversify, eventually, the market is going to rebound, and the value of your investments is going to increase again.

blog comments powered by Disqus