Investment risk – what is it and how can it be minimized?

Investment risk is one of the most important concepts that investors should be familiar with. Why? Because it is an inherent part of investing money in various assets, resulting from various factors, such as the volatility of financial markets. Although investing can be exciting, it is worth being prepared for anything.

Investing is an opportunity to make a profit, but every investment also carries the risk of loss. This is due, among other things, to the market situation, which can be very dynamic, meaning that it is not always possible to predict everything.

Usually, the higher the risk, the greater the potential returns on investment, but also... the greater the losses. Of course, every investor should make every effort to properly identify investment risk factors and respond to them skillfully in real time. That's why in this article we will tell you:

• What is investment risk and why is it important?
• The most common types of investment risk
• What factors influence the level of investment risk?
• How to assess risk before making an investment?
• Investment risk management strategies
• How to minimize investment risk in practice?

What is investment risk and why is it important?

The definition of investment risk is simple – it is an inherent part of every investment and the possibility that the investment will not bring the desired results, and the investor will incur financial losses or the results will be worse than expected.

Every investment involves uncertainty about future gains or losses, regardless of whether you invest in stocks, bonds, mutual funds, or other assets. Understanding this concept and managing risk skillfully is the first step to successful investing.

Investment risk – you know what it is. Now let's talk about why it is so important in the investment process. The financial market is changing rapidly, and investment risk directly affects our ability to make decisions and is linked to potential returns. The higher the risk, the higher the potential returns, but also the greater the risk of loss. The most important thing is to keep track of market changes, be able to assess and then reduce risk in order to achieve your financial goals.

Proper risk assessment allows you to make informed decisions, tailoring strategies not only to your goals, but also to your risk tolerance and expected returns.

The most common types of investment risk

Understanding what investment risk is is one thing. It is equally important to learn about the different types of risk. Here they are.

1. Market risk – one of the most common types of risk, covers general changes in financial markets. It is related to fluctuations in the value of investments, which may be caused by, for example, changes in stock and bond prices or rising interest rates. In this case, you have no control over how the market will behave, which means that every step you take involves the risk of losses, sometimes very large ones.
2. Currency risk – primarily affects investors operating on international markets. In this case, everything depends on changes in exchange rates, which may increase or decrease the value of investments in foreign currencies.
3. Political risk – relates to changes at the policy level, including taxes.
4. Credit risk – relates to situations where the bond issuer or other debtor is unable to repay its financial obligations. If you invest in debt instruments, you must take into account the risk of the issuer's insolvency.
5. Interest rate risk – applies to investments in debt instruments, such as Treasury bonds, and results from the possibility of interest rate changes. When interest rates rise, the value of bonds falls, which means that investors may lose money on their sale, as they become less attractive than newly issued securities with higher rates of return.
6. Liquidity risk – investing involves the risk of difficulty in selling assets quickly and at an attractive price.
7. Inflation risk – refers to situations where the value of money decreases over time, resulting in a reduction in the purchasing power of your investments. This means that even if an investment generates profits, high inflation can reduce the actual value of those profits. In other words, if the return on investment is lower than the rate of inflation, the investor loses value on their investment.
8. Concentration risk – this refers to a situation where you invest too much in a single asset. Although this may seem like a good idea in theory, in reality, a lack of diversification in your investment portfolio increases the risk of significant losses.

What factors influence the level of investment risk?

The level of investment risk depends on many factors, both internal and external. These may vary depending on the type of investment and market conditions. Among the most common are market volatility, macroeconomic conditions, the type of financial instrument, and the investor's experience.

1. Type of financial instrument – choosing the right investment instrument is crucial for the level of risk. Some instruments, such as shares in small technology companies, carry a higher risk than government bonds.
2. Investment period – the longer the investment period, the greater the risk associated with unpredictable market changes.
3. Portfolio diversification – a portfolio focused solely on one type of asset is characterized by higher risk. Diversification allows specific risk to be reduced.
4. Financial indicators – analyzing indicators such as beta or credit rating allows for a better understanding of the level of risk associated with an investment.
5. Industry conditions – some industries, such as technology, are riskier than those considered stable, such as real estate. Therefore, the choice of investment sector is important.
6. Macroeconomic conditions – factors such as inflation, interest rates, and economic growth have a huge impact on the level of investment risk.
7. Investor experience – an investor's skills, knowledge, and risk tolerance directly affect their ability to manage risk.

How to assess risk before making an investment?

Investment risk assessment is a process consisting of several steps. It allows you to tailor your investment strategies to your personal goals and, above all, facilitates informed decision-making. In this situation, it is important to have access to reliable, verified data and to use risk assessment tools.

The following are helpful in risk assessment:

1. Define your investment goal – this will help you better tailor your investment to your needs and risk tolerance.
2. Assess your risk tolerance – you need to know whether you can accept fluctuations in the value of your investments. If you have a high risk tolerance, you can invest in more volatile assets, and if you are too emotional, go for something more stable.
3. Portfolio diversification analysis – by analyzing the correlation between different assets, you can more easily assess the impact of diversification on the risk of the entire portfolio.
4. Simulations of extreme market conditions – these give you the opportunity to understand how your investment portfolio will behave in extremely unfavorable situations.
5. Fundamental analysis – this is an assessment of the intrinsic value of an asset by examining macroeconomic factors and the finances of the company you want to invest in. The analysis covers, among other things, financial data such as revenue, profits, debt, and liquidity, as well as market indicators and the market environment (industry trends, economic situation). This determines the stability of the potential of the selected investment and, at the same time, reveals the risks associated with changes in the macroeconomic environment.
6. Technical analysis – examining historical data, such as prices and transaction volumes, to predict future price movements. It uses price charts and indicators such as moving averages, RSI (relative strength index), and MACD (moving average convergence/divergence) to help assess whether the market is overbought or oversold.
7. Analysis of historical results – reviewing the previous results of a given investment facilitates risk assessment. Using historical data, it is possible to estimate future volatility and potential risk.
8. Market volatility analysis – thorough knowledge of the market situation and a specific industry allows for a better understanding of potential risks and enables timely responses to threats.
9. Various types of risk management software – these combine different risk assessment methods to provide comprehensive solutions for portfolio risk analysis and monitoring.
10. Financial instrument – examine instruments, i.e., various tools used to manage money or capital, in which you plan to invest.

Investment risk management strategies

Investment risk is an inherent part of any investment. Although it is impossible to eliminate risk entirely, it can be minimized by incurring as little loss as possible. Do you want to manage investment risk effectively? Take a holistic approach, remembering that market conditions can be dynamic. 

Risk management is a process that involves:

• identification,
• assessment,
• taking measures to minimize potential losses.

The most important risk management strategies include:

1. Portfolio diversification – a key element of risk management. Its purpose is to spread capital across different types of assets, thereby reducing the risk associated with the poor performance of a single type of investment.
2. Risk tolerance – allows you to tailor your investment strategy to your own capabilities. If you are someone with a lower risk tolerance, avoid aggressive investments and focus on stable assets such as treasury bonds.
3. Use a long-term investment strategy – it is worth bearing in mind that financial markets tend to grow in the long term. Even if there is a downward trend in the short term, over the years the market will reflect economic growth.
4. Regular portfolio analysis and monitoring – analyzing the macroeconomic situation and adjusting the investment strategy to market conditions helps reduce risk.
5. Set clear investment goals – it is worth determining the level of risk that is acceptable to you and having a realistic approach to potential losses. This way, you can avoid making impulsive decisions during difficult times on the market.
6. Stop Loss Orders – allow you to assess risk and profit, and are used to close investments when the market turns against them.
7. Investing in low-risk funds – recommended for novice investors as well as people with low risk tolerance who value high investment security. Investment funds and risk? The level of risk depends mainly on the type of assets in which the funds invest. For example, debt funds have a lower potential return, but at the same time are characterized by lower risk. By distinguishing between funds, you can control the level of risk.
8. Using the services of a financial advisor is one of the most effective ways to manage risk. A specialist will identify assets that are worth investing in and then tailor strategies to the client's capabilities and expectations.
9. Hedging – a strategy aimed at protecting investments against unfavorable market movements. What does this mean? Some financial instruments have an inverse correlation with others, which means that they can be used as a hedge in the event of a worst-case scenario in which a given investment loses value.
10. Consistency – sticking to your goals is the key to success, even if it means that sometimes you add more to your positions and sometimes less.

How to minimize investment risk in practice?

Risk is inevitable, but proper investment risk management can significantly reduce potential losses. Here's what you can do.

1. Systematic market research and monitoring.
2. Developing a plan for investment decisions.
3. Preparing scenarios of potential events and their consequences.
4. Long-term investing.
5. Maintaining liquidity.

All these measures will help minimize investment risk.

This information is of a general nature only and should not be treated as investment advice within the meaning of applicable law. Investing in precious metals, among other things, may involve risk. Before making any investment decisions, it is recommended that you consult a financial advisor for an individual assessment of your investment options.