If you place money in an institution by means of a term deposit, for example, you want to feel confident that you will get your money back–principal and interest–if the institution fails.
Another form of repayment risk is receiving your invested money back sooner than you expect or want it. For example, if you lock into a bond with a 12 per cent yield and the rate falls to five per cent, you will not be able to replace that bond with a new one at the same yield if the bond issuer redeems or calls the bond earlier than anticipated. Many corporate bond issuers have this right a certain number of years after the bond was issued. Most government bonds cannot be called.
Market cycle risk
Many markets, such as the real estate market, stock market and bond market, are cyclical. Depending on where your investment is at any point in the cycle, it could slowly or rapidly diminish in value. If you wanted or needed to sell it, you could lose money. Being aware of the market and the direction of the cycle is obviously important. Generally, the longer you hold an investment, the less the risk. The shorter the term you intend to keep the investment, the higher the risk that a market correction could impair your investment return.
Economic risk
The economy obviously has an effect on investments such as real estate and stocks. The more buoyant the economy, the more buoyant the price of real estate and stocks.
Lack-of-diversification risk
The risk here is having all your assets in one specific kind of investment, like real estate or bonds or stocks. You are not protected if that asset drops in value and you do not have alternative assets to buffer the loss. If you spread the risk, you lower the risk. To spread the risk, you should not only have different types of assets, but also have different kinds of investments within each type of asset.
Lack-of-liquidity risk
“Liquidity” is the speed at which you can sell your asset–be it at a fair price, or at all. For example, if you need to sell your home or stocks and the market has dropped, you could still sell, but it could take much longer and you will get a lower price. Negative publicity about stocks and real estate can have a dramatic short-term effect on the market, as potential buyers become nervous. Less demand means lower prices.
