What are the four main types of risk?
There are four main types of risk that can affect your investments in different ways.
- Inflation risk—Inflation is when prices increase over time. This could mean that your investments might not have as much buying power if your returns don't keep up with inflation.
- Market risk—The stock market can vary day to day, which can affect the returns and performance of your investments.
- Interest risk—Changes in interest rates can reduce or increase your fixed-income investment returns like guaranteed income certificates or bonds.
- Longevity risk—Longevity risk is the possibility that you could outlive your savings. You want to be prepared with enough money saved for your whole retirement.
You could also add currency risk to this list, as the Canadian market is only a small portion of global markets. To be well diversified, a portfolio should include some foreign investments.
Can you avoid risk in an investment?
If you want a return on your investment, you can’t usually avoid risk. But you can figure out what type of investor you are, your appetite for risk (how much risk you might be comfortable taking on), and your level of investment knowledge to feel more comfortable.
What type of investor are you? Three questions to ask yourself
Do the ups and downs of the market make you uncomfortable?
Consider your risk tolerance—are you looking for safety and low-risk investments, or can you handle higher risk with the potential for higher returns on your investments? Filling in an investor profile questionnaire is a good place to start. Knowing your goals and your risk tolerance can help you pick the best funds for you.
What’s your time horizon?
Consider when you want to have access to your money. Usually, when you have a long time horizon for your goals, like saving for retirement when you’re just starting out, you may take on more risk. But as you get closer to retirement, you usually reduce the risks you take on. Your age, life stage, and time horizon to retirement are important factors to consider when investing.
What are your goals?
The top financial goals among Canadians are paying off debt, investing wisely, and planning for retirement. What are you saving for? Get personal about exactly what you want or need, including the amount of savings you'd need to reach that goal. You might be more willing to take on riskier investments to achieve a specific lifestyle like more travel or early retirement. If your goals are simpler, and you have a more conservative investor profile, you may want to invest in low-risk funds.
Don’t forget to regularly review your investments together with your goals to make sure they’re still aligned.
How do you identify investment risks?
As we saw earlier, inflation, longevity, market, and interest risks are some of the main types of investment risks that can affect your investment returns. Identifying investment risk isn't always easy. You may want to consider a diversified portfolio, which can minimize risk by having different types of investments such as fixed income, equities, and investments in different locations around the world.
Do-it-yourself investors can pick from various funds that fit their risk profile, investment knowledge, and time they want to allocate to manage their portfolio.
If you aren’t sure how to identify risk, you can invest in ready-made funds like an asset allocation fund, or a target-date fund based on your risk profile or time horizon. You pick your goal and the fund manager picks the funds to help you reach it within a certain level of risk.
Are you ready to start investing?
Whether you are just getting started or are looking to change your current approach to investment risk, it’s always smart to:
- Review your investments regularly to make sure you’re staying on track
- Update your investor risk profile as your personal situation and goals evolve
- Talk to your financial advisor
Your investment choices should ultimately be driven by your risk tolerance, time horizon, and goals. Getting advice from a financial advisor can help you in achieving your financial goals and support you along the way. It’s never too early or too late to start investing.
The commentary in this publication is for general information only and should not be considered legal, financial, or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation.