Investment Risks
All investing involves risk. Most investments involve
many different types of risk—anything that creates
uncertainty about your investment is a risk. Before you
make an investment, you need to determine what risks you
are taking and if you can—financially and physically—afford
to take those risks. The promoter of the investment should
tell you, in writing, what risks are involved in the investment
she or he is trying to sell you. You need to determine
if you can afford those risks.
The risk you absolutely must not take is the risk that
the investment is not legitimate. An iron clad rule about
risk is that the higher the potential rate of return on
an investment, the higher the risk you are taking that
you will not receive that return and, additionally, that
you may lose your initial investment. Always investigate
the salesperson and the investment before you hand over
your money.
Let’s assume, however, that you know that the
investment is legitimate. You have obtained all of the
representations about the investment in writing, you have
checked with the securities regulators to make sure the
securities and the salespeople are registered, you have
investigated the issuer of the securities, and you have
read the prospectus. What types of risk should you look
for to determine if this investment suits your goals?
- Market risk: the risk that the price for which
you can sell the investment will be lower than the price
you initially pay for it. A number of factors impact
market risk, including political, economic, and weather
conditions. Is the risk high that the market price of
the investment will be volatile? If so, can you afford
to hold the investment if the price drops until the
price comes back up? If you can’t hold the investment
because you need the money for something else at a specific
time, then you can reduce risk by buying a more stable
investment.
- Business risk: the possibility that the transaction
underlying an investment will not succeed. You can lose
money if the company’s competitors are better
than the company, people don’t buy the company’s
products, or the company’s officers don’t
manage the company well or are dishonest. You can lower
the business risk by investing in a business that is
established and has a successful track record, that
is run by experienced business people, and that sells
a product in which consumers have proven to be interested.
- Liquidity risk: the risk that you will not
be able to sell the investment quickly if you need or
want to. An investment in exchange-traded securities
is very liquid because you can buy or sell the securities
any time the exchange is open. An investment in a limited
partnership that owns raw land may not be as liquid
if no one is interested in that parcel of land when
you want to sell your interest.
- Inflation risk: the chance that the value of
investments will be eroded as inflation shrinks the
value of the country’s currency. You run the risk
that inflation will erode the value of your investment
if the return you receive on the investment is lower
than the inflation rate.
As in all things, you must ascertain and maintain the
appropriate balance between the risks you can afford and
are willing to take and the return you would like to receive
on your investment.
By W. Mark Sendrow
Director of The Arizona Corporation Commission Securities
Division
Article Date: 03-29-2002
The Arizona Corporation Commission disclaims responsibility
for any private publication or statement by any of its
employees. The views expressed herein are those of the
author and do not necessarily represent the views of the
Arizona Corporation Commission.
