Evaluating types of investment risks

Entering an investment market with awareness means invest money while considering your investment risk level you want to take.

In fact, all investments involve some degree of risk.

The investor must conclude a transaction only if he has fully understood the nature and level of risk assumed with that given investment.

Often the risk component is closely linked, with a proportional growth relationship, to profitability.

Each financial instrument has its own specific risk; therefore, it is advisable to start (with the advice of a professional expert in the sector) with the preliminary and necessary evaluation of the risk.

Risk assessment

The first aspect to take into consideration is the type of the chosen financial instrument.

In this regard, we can distinguish between equity securities (such as shares) and debt securities (such as bonds).

With the former, you become the owner of a portion of the company (you become shareholders), you will participate with it in the economic risk (including the possibility that the majority decides not to share the profits).

By purchasing debt securities, on the other hand, you become lender of the companies or entities that issued the securities and you will receive the interest envisaged by the regulations and, upon maturity of the security, the principal will also be repaid.

It seems clear that in the purchase of equity securities, subject to market trends, the risk will be greater for the investor.

On the other hand, for debt securities, the investor risks losing the entire capital only in the event of financial instability of the issuing institution or company.

Moreover, in the event of bankruptcy, it will be able to participate in the distribution of profits obtained, for example, from the sale of the assets owned by the company (almost excluded for shareholders).

Types of risk

The risk of an investment, whether made through the purchase of equity securities or debt securities, is made up of two elements: generic risk and specific risk.

Generic risk is influenced by fluctuations in market interest rates, which have a direct effect on the increase or decrease in the prices of the securities themselves.

In fact, those who invest in debt securities must always remember this peculiarity of this investment instrument: the value will vary continuously because it adapts to market conditions.

Therefore, the actual return on the security “promised” at the time of purchase can only be achieved upon maturity of the security.

In the event of an exchange (or sale) of the security during its “life” – i.e., before the expiry date set in the issue regulation – a margin of profitability of the transaction is not always ensured.

Therefore, it is essential for the investor to verify that he has the possibility to wait for the timing of the chosen security and to adapt his choice to his needs.

Specific risk is closely related to a subjective element, namely: who issues the security.

For anyone buying a share capital, it is essential to make a careful assessment of the issuing company, its characteristics and peculiarities as well as a precise analysis of the sector in which it operates.

Obviously, given that the specific risk is different for each share, the investor can significantly reduce it by diversifying the investment portfolio.

As a matter of fact, opting for different securities, issued by different companies and, possibly, in markets different will allow you to cushion any losses from one stock with profits from another.

The risks associated with investing belong to multiple nature and only through the advice of a professional the damage can be limited.

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