8 Hidden Investment Risks

By in Advanced Investing, Guest Post | 3 comments

By Guest Contributor, Paul A. Tucci

Don’t Be Caught Off Guard By Investment Risk

Don’t be nervous about investment risks. There are risks or possible negative outcomes in nearly everything you do. You might lose your job, have a huge unplanned bill or medical expense, or an automobile accident. You may undoubtedly buy the wrong sized shoes or clothes, your children might get sick or you might crack a tooth while eating something. 

In investing, some risks are apparent and obvious, while others may be hidden from view, no matter how much time  you spend managing your investments. The key to surviving these hidden risks is to be prepared for your reaction to the news as well as the reactions of others.

It is equally important to distinguish the difference between news that causes short term blips in the value of your portfolio and those events and associated risks that may have more long term consequences.

Understand hidden investment risk to prepare for market corrections

 How to Prepare for Investment Risks

In order to prepare for many different risks and help to mitigate the outcome of a less than desirable event, it is important to keep your financial house in order.

Are you  in some sort of exotic investments that an adviser or friend suggested?  It is best to clear your portfolio of any instruments that you don’t understand.

Do you have enough cash socked away to make future investments in the case of a market decline?  

Understand Hidden Investment Risks

There are many hidden risks that may require some action on your part- events that may happen which will test your investment discipline and reactions. Some of these risks may include:

Risk 1: Natural disasters.  There could be a natural event that stops investment trading in some key location, caused by rains, earthquakes or hurricanes. Or there could be a large scale disaster that fundamentally changes the consumer buying behavior of an important trading partner.

Risk 2:  Disruption in the pumping, refinement and transportation of oil. Because oil and its production is such a large component of the global economy, any disruption in the supply, refinement and flow causes many types of markets to react, often negatively. Political movements and policies, wars and acts of terrorism may cause short or long term changes in petroleum prices, affecting many investments in your portfolio.

Risk 3: An abrupt change in exchange rates. The world is tied together by billions of transactions every second. Many of these transactions require, at some point, foreign currency. So when a government or financial institution  acting on behalf of a government,  decides to change the value of the currency relative to any others, especially if it is unannounced, a ripple effect within many economies  may occur.

Risk 4: An unexpected change in interest rates. As in the example above, if a government or financial institution associated with a government, decides to change the interest rate or price of the currency, especially if it is unexpected, it may negatively (or positively, in some cases) affect your portfolio. There are many reasons interest rates may change abruptly;  the government might be under political or economic pressure or a new leader is elected or a current government is changed and the long standing policy on interest rates is changed. For example, the recent low interest rate environment is tied to the current investment bull market.

 Risk 5:  High unanticipated corporate expenses.  For portfolios that are heavily weighted toward equities, unplanned corporate expenses may cause a blip in the valuation of a stock. The company may have lost a legal battle, a key competitor may announce a game-changing technology that requires greater expenses amongst all other competitors in the segment, causing profits to be depressed.  Whenever market analysts (those who analyze and publish content regarding a particular stock) are negatively surprised, bad things can happen to the price and value of the stock.

Risk 6: The use or misuse of technology. If a company uses technology improperly, perhaps borrowing an interface design from a competitor, a critical security breach of a computer system, or an unplanned environmental event, the individual stock price may change and many other stock prices may  be impacted. Perhaps a disclosure is made for the first time in a public hearing or a journalist uncovers some critical technology misstep that causes a stock price to fall abruptly.

 Risk 7:  A change in credit ratings by outside firms.  If a company uses markets to obtain capital through the use of bonds and credit, they are followed by various ratings agencies like Moody’s, Standard and Poor’s, and Fitch. These agencies look at the overall health of the company in order to ascertain how well the company may pay off or pay back debt. If the company is using debt unwisely, and has a cash problem, it may not be able to pay its current obligations and may be abruptly downgraded, sending its stock into a tailspin. (This was a big problem during the recent financial crisis.)

Risk 8: An unpredicted, negative change in a macro-statistic, like employment. The markets use many macro-reports, like the unemployment rate, various price indices, etc., as barometers that gauge the economy’s health. If there is an unexpected change in what is commonly predicted in a piece of macro-data, especially if it is negative, markets broadly react, sending many stocks of all types down in prices. Sometimes macro-data may not be interpreted properly. Unemployment may decrease, while real incomes decrease which is not good for an economy of people who buy things.  Macro-data released can be negative, without ill-effect if the markets expect this movement. It is the surprises that cause markets to stir. 

So be careful to consider many of these and other factors, when making and managing any investments. 

The Takeaway-Barbara’s Investment Risk Comments

An investment portfolio with broad diversification can help the investor weather the inevitable market risks. It’s also important to be an informed investor. Understand what financial assets are in your investment portfolio and never blindly follow the advice of an advisor. No one cares more about your money than you do. Keep abreast of current economic news and how this news can impact your money.

Although risk is everywhere, setting up a diversified portfolio with a wide variety investments and keeping a good cash cushion will help you weather the storms of unexpected investment risks.

About the author:

Paul A. Tucci is the author of The Handy Investing Answer Book (Visible Ink Press / $21.95 / September 2014). Mr. Tucci consults for and invests in small private-equity-funded businesses and he has been an amateur investor for more than 30 years and is also the author of The Handy Personal Finance Answer Book (Visible Ink Press / 2011) and numerous articles regarding the information industry. His new book is a helpful primer that answers more than 1,400 common questions on investing

 

    3 Comments

  1. Given that professional money managers regularly miscalculate investment risks and underperform the market, despite their experience, their connections and the long hours they spend analysing markets, doesn’t that suggest that the amateur investor would be better off with a fund which tracks the S&P?

    Myles Money

    October 14, 2014

  2. Myles, I am a proponent in investing with a diversified index fund portfolio. In most cases, that’s the best way to lower risk while keeping returns better than 60-70% of active fund managers. I do watch for the economic cycles, and during the market troughs, invest a bit more.

    Barbara Friedberg

    October 15, 2014

  3. Thank you for sharing article! It’s very interesting. Hope to hear more from you.

    Pascal Boivin

    November 11, 2014

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