Risks are a part and parcel of investing. Each financial product has its own set of risk factors, while other factors are common to the entire market. For instruments like FDs, the risk factors in investment are minimal. However, for others, like stocks and options, the risks can be substantial. Generally, a higher risk exposure is linked to the possibility of higher returns. That said, experienced investors know how to manage risks to keep making profits. 

• Market risks are unavoidable, but can be managed with better market knowledge and trend analysis.
• Callable bonds present call risks, while currency risk is associated with foreign investments.
• Optimum diversification can help manage allocation risk and inflation risk.

The market risk factor in investment refers to the possibility that your investment may experience volatility or underperformance due to market declines. In essence, it refers to the chances of losses due to factors that impact the overall market performance, not just one specific investment.

How to avoid: Market risk is more or less unavoidable since it occurs due to macro forces beyond the control of individual investors. However, gaining knowledge about market risk and how the overall market operates can help. Monitoring factors like geopolitical events, interest rates, and inflation can also be instrumental in adjusting your investment and trading strategies.

If you are looking for a safe investment option, you can consider fixed deposit. They offer guaranteed returns and a fixed interest rate throughout your investment tenure.

Some bonds have a call-back option built into the bond sale agreement. The issuing company can exercise this call option to repay the bond earlier. When the bond is redeemed, the issuer repays the principal amount to the investor and stops making further coupon (interest) payments. Generally, bond issuers exercise the call option if the applicable coupon rate on the existing bond today is lower than what they expect to pay in the future. The call option becomes a risk factor in investment because you now have to reinvest your corpus at a lower interest rate. Moreover, you lose out on upcoming coupon income.

How to avoid: If you rely on coupon income to meet immediate living expenses, avoid callable bonds. Invest in non-callable bonds, debt funds, and ETFs instead.

Inflation risk is the risk that the rate of return on an investment will be outpaced by the rise in the inflation rate. If the rate of return on a certain investment falls lower than the inflation rate, your real return from the investment goes down. Real return is the purchasing power of your yields. Therefore, inflation risk is also commonly known as purchasing power risk.

How to avoid: You can minimise this risk factor in investment by adding inflation hedges to your portfolio. Common inflation hedges include gold, commodities, and real estate. Diversification into these assets can help your portfolio’s returns weather inflationary pressures and conserve the value of your real returns.

As the name suggests, allocation risk is the risk that is caused by an inappropriate asset allocation mix. According to financial experts, a balanced mix can help minimise the impact of volatility on your portfolio’s returns and manage the risk factors in investment. For instance, most experts suggest an equity-focused portfolio in your 20s and 30s since you have ample time to recover from possible losses. However, as you age and near retirement, it’s prudent to shift your portfolio to fixed-income assets like bonds to preserve the returns generated and avoid unnecessary volatility-linked losses.

You can consider investing Bajaj Finance Fixed Deposit. With a top-tier AAA rating from financial agencies like CRISIL and ICRA, they offer one of the highest returns, up to 8.60% p.a.

When you invest in foreign assets, you expose yourself to currency risk or foreign exchange risk. Under currency risk, your investment may incur losses or underperform due to changes in exchange rates. Let’s take an example to understand currency risk better. Suppose you have invested in the US market from India and the value of the US Dollar (USD) appreciates against the Indian Rupee (INR). Your investment in rupee terms will increase. However, if the USD depreciates against the INR, your investment value in rupee terms will also decline, resulting in losses despite the positive performance of the US market.

How to avoid: Currency hedging is a prudent strategy designed to mitigate the impact of FX rate fluctuations on international investment returns. You can minimise this risk factor in investment with instruments like a forward contract. A forward contract is an agreement to sell the currency at a predetermined price on a future date. Options and spot contracts are also currency-hedging instruments.

Liquidity risk is the risk that you won’t be able to redeem your investment quickly due to the limited number of buyers for the security. In simple words, you won’t be able to liquidate your investment into cash. Liquidity risk factors in investment can also force you to settle for a lower selling price and incur losses. Generally, liquidity risk arises at times of extreme economic stress, when investors are panic selling.

How to avoid: One way to avoid this risk factor in investment is to steer clear of investments that have a low liquidity. Generally, investments like thematic ETFs and physical real estate have low liquidity. 

The act of investing comes with the promise of returns but also the possibility of risks. As an investor, you can overlook the various risk factors in investment. Your investment strategy must account for these risks and devise ways of managing them to maximise your gains from the investment.