An overview of the different types of investment risk and understanding how to manage it
Any investment, no matter how seemingly secure it may be, carries with it at least some level of financial risk. To be successful as an investor, it’s important that you know your own risk comfort level and develop the skill to accurately evaluate how risky different investments are to determine if they are right for your portfolio.
Below, you’ll find several types of investment risk described in detail so that you can gain a better understanding of what kinds of risks are built into any given investment.
But first, let’s start with the basics by asking an important question: What is risk?
Risk is a probability or threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities, and that may be avoided through preemptive action. In finance, risk is the probability that an actual return on an investment will be lower than the expected return. (source)
One of the most common and substantial risks associated with many types of investments is liquidity. Liquidity risk refers to the uncertainty that you won’t be able to sell your assets when you want to. Though there is liquidity risk in almost all markets, it applies differently to different types of assets.
Securities with high trading volumes, such as major blue chip stocks, tend to have a fairly low liquidity risk unless a major stock market selloff is underway. Real estate investments, by contrast, are extremely vulnerable to liquidity risk, sometimes taking months or even years to sell.
Before investing in an asset, be sure you know how easy or difficult it may be to sell off should you decide to do so.
Inflation is the risk factor in which the growth of an asset’s value is less than the rate of inflation over time, thus decreasing the purchasing power of that value. Inflation risk applies mostly to lower-return investments, such as government bonds and certificates of deposit. Higher-return assets, such as stocks, tend to be more sheltered from inflation risk.
It’s important to note, however, that even high-return assets aren’t immune from inflation risk, since fast-paced inflation during periods of economic stagnation can eat into the purchasing power of a stock’s value.
Investments that offer a “hedge” against inflation risk include precious metals like gold and silver bullion, which is one of many reasons why investors prefer to diversify in this way.
Fraud is relatively uncommon in most markets and less of a threat compared to inflation or liquidity, but it’s still important to be aware of it. Fraud can take several different forms. Outright forging of assets is quite rare, though it can still take place in the collectibles market. For instance, a seller on eBay may claim that a gold coin is real and authentic, but when the buyer receives their asset in the mail they see that it’s a fake.
Much more common is fraud that’s intended to artificially inflate the price of a real asset. Companies falsely reporting high earnings and sellers of real estate making false claims about the condition of a property would fall under this more common category of fraud.
The best way to avoid fraud is to work with trusted companies and asset brokers that can help to independently verify an asset. Be aware that when you are a victim of fraud, you generally have legal recourse that can help you to recoup some or all of the capital you’ve invested.
The single biggest risk across various classes of investments is market risk. Market risk refers to the unpredictability that the price of a given asset could go up or down due to changes in the market, thus producing a negative return on investment. Hypothetically, all classes of assets are exposed to market risk in one way or another.
Low-yield bonds are considerably more shielded from market risk than most other assets, but even they carry the risk of default in the unlikely event that the country that issued them will have to default on its debts at some point in the future. Stocks and real estate are highly exposed to market risk, as prices for these assets move dynamically at all times, even under normal market conditions.
Of course, market risk has its upside, as well as its downside. An asset that can lose value through dynamic price fluctuations can also gain value in the same way, allowing it to post higher return rates than assets that are more shielded from market risk. This dichotomy is why every investor should know how much risk he or she is comfortable with.
Precious metal investments, like any other assets, are exposed to various types of risks. However, they have also been among the safest long-term investments historically. Precious metals are particularly strong hedges against inflation risk, and have often been used by investors as a safe haven to move cash into when inflationary periods appear imminent. In fact, most countries keep reserves of gold on hand specifically to buoy their currencies against the risk of hyperinflation, which can be one of the most destructive economic conditions.
|Type of Investment
|Bullion (coins and bars)
|Rare coins (collectibles)
|Major mining companies
|Low - Medium
|Midsize mining companies
|Junior mining companies
|Exchange traded funds (ETFs)
|Covered call writing options
|Buying calls and puts options
Precious metals are subject to market risk like most other investments, but again they prove to be more robust than most assets. Since money often flows into precious metals when general economic downturns begin, gold, silver and platinum tend to be resilient to recessions.
Nevertheless, there have been instances in which market risk has affected precious metals. Such spikes can be caused by the movement of too much capital into precious metals when economic conditions are at their worst, which is why it’s generally recommended that investors integrate precious metals into your portfolio during good economic times, when prices are apt to be more reasonable.
Some stores of metal are subject to fraud. Antique coins, in particular, can be forged. One of the most disastrous types of fraud associated with precious metal investment is the occasional creation of fake gold bars. When plated with an appropriate covering of gold, tungsten, the metal closest to gold in terms of its density, is virtually indistinguishable from its much more valuable counterpart. Such gold forgeries are quite rare, but they do represent yet another reason to always do business only with reputable, trustworthy precious metal dealers, like Provident Metals.
Liquidity risk is rarely a problem for precious metal investors. Because the global market is so large, there’s almost always a buyer prepared to purchase gold or silver. When it comes to physical gold and silver, the biggest challenge is typically arranging secure shipping to the buyer.
Overall, precious metals represent one of the most secure class of assets. Though all assets face some risk, gold and silver are much less exposed than other financial investment counterparts. If you’re a risk-averse investor or an investor looking to balance your portfolio with some low-risk assets, buying physical precious metals and diversifying your portfolio is one of the best investments you can make right now.
Continue browsing the Provident Metals website for a wide range of precious metal investments you can buy, such as gold bullion, silver bullion, bars, coins, rounds, and much more.