Why do you need to know about financial risks?

There are many ways to reduce the impact of different risks, but the most effective way to deal with risk is to recognise and plan for it.

Any investment decision you make means that you must take a risk of some sort. And the decision will relate to the amount of money you invest, your circumstances at the time and your needs for the future.

Basically, risk is the chance that you will not achieve your financial goals.

With a better understanding of risk, you can make a more informed investment decision - accepting some risks and rejecting others. The important point is that you understand the relationship between risk and reward, particularly over your investment timeframe.

This page does not deal with other kinds of unexpected events such as serious illness, death or loss of employment which can have a major impact on a person's financial situation. Your financial planner can provide you with appropriate advice on risk insurance protection.

The golden rule is: the higher the expected returns, the higher the likely risk.

Usually when you make an informed decision to take on a certain risk, you create the opportunity for greater returns. Generally, the higher the level of risk you are prepared to accept when investing, the higher the potential return will be. At the same time, the potential loss may also be higher. This is called the risk/reward trade-off.

Nine Types of Risk

Types of Risk	What they mean
1. Mismatch Risk	The investment you choose may not be suitable for your needs and circumstances.
2. Inflation Risk	The real purchasing power of your money may not keep pace with inflation.
3. Interest Rate Risk	For investors relying on fixed rate investments, you may have to reinvest maturing money at a significantly lower rate.
4. Market Risk	Movements in the market mean the value of your investment can go down as well as up, and sometimes suddenly.
5. Market Timing Risk	Anticipating market rises and falls can be extremely difficult because no two economic cycles are the same.
6. Risk Of Not Diversifying	All of your capital will be affected if your single investment does badly.
7. Liquidity Risk	You may not be able to access your money quickly or without cost when you need to.
8. Credit Risk	Applies to debt type investments such as term deposits and debentures. The institution you have invested with may not be able to make the required interest payments or repay your funds.
9. Legislative Risk	Your investment strategies could be affected by changes in the current laws and regulations.

Reproduced with the kind permission of the FPA and Macquarie Investment Management Limited

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