There is some risk, called systemic risk,
that you can't control. But if you learn to accept risk as
a normal part of investing, you can develop asset allocation and
diversification strategies to help ease the impact of these situations.
And knowing how to tolerate risk and avoid panic selling is part
of a smart investment plan.
Market risk. This
is the possibility that the financial markets will drop in
value and create a ripple effect in your portfolio. For example,
if the stock market as a whole loses value, chances are your
stocks or stock funds will decrease in value as well until
the market returns to a period of growth. Market risk exposes
you to potential loss of
principal,
since some companies don't survive market downturns.
But the greater threat is the loss of principal that can result
from selling when prices are low.
Interest raterisk. This is the possibility that interest
rates will go up. If that happens, inflation increases, and
the value of existing bonds and other fixed-income investments
declines, since they're worth less to investors than
newly issued bonds paying a higher rate. Rising interest rates
also usually mean lower stock prices, since investors put
more money into interest-paying investments because they can
get a strong return with less risk.
Recessionrisk. A recession,
or period of economic slowdown, means many investments could
lose value and make investing seem riskier.
Currency risk. Currency
fluctuations affect the value of your overseas investments
and may also affect the value of domestic investments in companies
whose products can be undersold by overseas producers.
Political risk. With the increasing interaction of the world's markets,
political climates around the world can affect the value of
your domestic and international investments. A period of instability,
for example, can drive the value of your investments down,
while political stability and growth can increase their value.
