What is Investment Risk?
Like scales reward does't come without risk. However the biggest risk is not knowing of its existence.
Investors are sometimes prone to play favourite and invest in a single asset class like low returning fixed income or Australian Bluechip stocks. By putting all your eggs in one basket an investment is prone to specific or sector risk.
Don’t be discouraged, it is a behavioural trait of most of us to have a bias to one asset class over another. Feeling comfortable with an asset class that you may understand well like property or investing in the status quo or perhaps putting weight on shorter term reactions rather than a longer-term horizon makes a portfolio subject to increased risk.
There are many risks and biases you face when picking an investment (managed funds, ETFs, LICs, stocks, property, bonds etc.) but two that are probably the most important are Specific risk and Sector risk.
What is Specific Risk? – Risk that affects a specific company or group of companies and is subject to devaluation due to internal actions.
What is Sector Risk? – Risk that affects a sector or asset class which is subject to external influences such as commodity prices, government regulation or force majeure.
"The biggest risk is not taking any risk… In a world that changing really quickly [sic], the only strategy that is guaranteed to fail is not taking risks."
We should also highlight market risk as another component which brings investments under pressure. Market risk or Systematic risk is an overall collapse of the market such as in 2008 when the US banking system failed. All sectors and assets found themselves struggling to stay in the black.
We are all very aware of the collapse of the “system” back in 2008. The GFC was the worst in history. Some of you may have had super funds, managed funds or ETFs that tracked indexes which were subject to the downturn. Especially if you were retiring at or around this time looking to draw down on your retirement savings you would have seen a sharp depreciation in the value of your investments.
Remember, at the time of the downturn no one was expecting a fast recovery. The crash of 1929 left the world in a depression for a decade. And, the last major crash of 1987, 17 of the 18 major OECD economies experienced a recession in the early 1990s. Australia took 2 years to recover leaving high interest rates, so you would be forgiven if you were in a bit of a panic.
Go to next section: 101: Creating an investment portfolio