What Is Investment Risk?
Risk in investing isn't just about losing money. It's about uncertainty. Understanding the different types of risk helps you make smarter decisions.
Risk vs. Volatility
Volatility is how much an investment's price swings up and down. Risk is broader: it's the chance you won't meet your financial goals. High volatility doesn't always mean high risk if you have a long time horizon and can ride out the swings.
Types of Investment Risk
Market risk affects all investments when the overall market moves. Company-specific risk affects individual stocks (a CEO scandal, product failure). Inflation risk erodes purchasing power over time. Interest rate risk affects bonds when rates change.
Market Risk
- Affects all investments
- Can't be diversified away
- Examples: recessions, pandemics
Specific Risk
- Affects single companies
- Can be diversified away
- Examples: lawsuits, bad earnings
Inflation Risk
- Erodes purchasing power
- Affects cash & bonds most
- Stocks often hedge against it
The Risk-Return Tradeoff
Higher potential returns come with higher risk. Stocks have outperformed bonds over the long term, but with much more volatility. Treasury bonds are safe but barely beat inflation. There's no free lunch: if someone promises high returns with no risk, run.
- Volatility is price swings; risk is the chance of not meeting your goals
- Diversification reduces company-specific risk but not market risk
- Higher expected returns always come with higher risk, no exceptions
Answer these questions to complete the checkpoint and unlock the next one.