Common Risks

Market Risk - The risk of the market in general is the risk that still exists after a portfolio is properly diversified. Academic theory holds that you cannot get rid of this risk. However, there are some non-market sensitive investments. Non-market sensitive investments perform independently of the market and have their own risks and rewards.

Credit Risk is more easily understood in terms of a bond. In that case, it is the risk that a creditor will not make the interest or principal payments as agreed to in the indenture. In terms of equities, it is the improvement or deterioration of a company's prospects due to improving or deteriorating financial results and expectations.

Interest Rate Risk is primarily the risk that affects most fixed income portfolios. It is the danger that interest rates will rise causing a bond's principal value to drop. There is an inverse relationship between the level of interest rates and bond prices. The prices of long-term bonds are much more sensitive to changes in interest rates than are the prices of short-term bonds. Therefore, in general, long-term bonds have more interest rate risk than short-term bonds. Specific security characteristics of bonds can mitigate or change the normal interest rate risk of a particular long-term bond.

Risk of Inflation is the risk that the value of one's investment will drop due to a rise in the prices of most goods and services in general. There is normally an expected level of inflation. The real risk here is that actual inflation will exceed the expected level. This is due to the fact that the yield on a security reflects the average inflation rate expected over the security's life. If a high inflation rate is expected in the future, that expectation is built into the interest rate of the security (along with other factors).

Risk of Deflation- The opposite of inflation is a risk that is rarely talked about today. That risk is deflation, which is a drop in the general price level of all goods and services. When deflation occurs, the economy slips into a depression, which is deeper than a recession or a normal business cycle low. When deflation occurs, almost all assets drop in value.