Types of Investment Risk - Non-Systematic Risks

  1. Business Risk (non-systematic; equities, bonds): is the risk that the business in which one invests experiences downturns or even fails due to any number of factors. Examples would be the delay of a product rollout, key employee turnover, etc.
  2. Liquidity and Marketability Risk (unsystematic; equities, bonds, real estate, private equity): an investment is liquid if it can be converted into cash quickly with minimal effect upon its value. Liquid investments are typically more desirable in consequence and more marketable. Less liquid or illiquid investments may or may not be marketable and, as a result, are better suited for investors with little or no need for near term liquidity. Investments in real estate (not securitized), private equity funds, hedge funds, any private placement, thinly traded stocks, all manner of distressed securities and private ventures are subject to such risks. Suitability requirements often exist. (e.g. investor accreditation rules).
  3. Financial Risk (unsystematic; equities, bonds): refers to the effect that a firm's capital structure may have upon its profitability. For example, large amounts of debt can act as a double edged sword, both increasing a firm's return on its equity (ROE) and possibly reducing it as well. Also termed event risk, financial risk can result from an event that impacts the credit quality such as leveraged buyouts, mergers, acquisitions, share buybacks, decapitalizations, recapitalizations and restructurings.
  4. Political or Sovereign Risk (unsystematic; foreign equities and bonds): refers to the investment risks unique to the country in which they originate. The effect of political and economic risks upon investment are examples. A tax to discourage short-term profit taking, renationalization of an industry are types of such risk.
  5. Tax Risk (unsystematic; equities, bonds): is the risk of an unfavorable change in investment taxation brought about by legislation. Examples would be an increase in marginal income tax rates or capital gains tax rates.
  6. Investment Manager Risk (unsystematic; equity and fixed income managers of any strategy in any structure): investors in mutual funds, separately managed accounts and hedge/private equity funds face such risk. Examples would be a change in investment philosophy and process, turnover of key personnel or the acquisition of a privately held money manager by a larger concern where the latter could effect a change in the acquired manager's investment thesis.
  7. Credit (Default) Risk (unsystematic, fixed income): refers to the issuer's inability to make interest or principal payments when due. This is a type of business risk that directly impacts a company's creditworthiness. It is also a form of event risk as occurrences such as mergers, acquisitions and buyouts often add to a company's debt burden, increasing the likelihood of default risk.
  8. Call Risk (unsystematic, fixed income): this is the risk assumed by an investor in callable bonds or preferred stock. When the general level of interest rates decreases, issuers will often exercise their right to call their bond to reissue one at a lower interest rate. Beneficial to the issuer, callable bonds subject investors to reinvestment risk.
Planners need to be aware of all manner of risk to which their clients may be subject. This chapter has outlined the major types, if they can be reduced or eliminated by diversification and the investments most susceptible to them. The plethora of risks in investing only underscores the need for the investor and planner to codify risk/return objectives along with any unique constraints and pursue prudent diversification.
Practice Questions 1 - 4


Related Articles
  1. Investing

    Under Armour Stock: Analyzing 5 Key Customers (UA)

    Learn about a handful of important sporting goods retailers purchasing and selling Under Armour products in the United States and European markets.
  2. Personal Finance

    Brazil Olympics: Trouble in Paradise?

    Get an in-depth look at the laundry list of unique problems in Brazil that may pose a serious threat to the success of the 2016 Brazil Summer Games.
  3. Entrepreneurship

    Amazon Stock: Analyzing 5 Key Customers (AMZN)

    Find out how Amazon.com became an e-commerce giant catering to customers' needs through innovation, technology and help from five of its key customers.
  4. Mutual Funds & ETFs

    VIMAX: Vanguard Mid-Cap Index Fund Performance Case Study

    Discover the performance trends of the Vanguard Mid-Cap Index Fund, and learn which times of the year the fund has performed its best and worst.
  5. Personal Finance

    Facebook Stock: An Earnings Case Study (FB)

    Explore an earnings case study on Facebook, and learn about its earnings, advertising revenue and total revenue growth rates during 2014 and 2015.
  6. Personal Finance

    3 Japanese Inflation and Policy Implications from PIMCO's Tadashi Kakuchi

    Learn three critical implications for policy and inflation of Japan's introduction of negative interest rates, based on comments by PIMCO's Tadashi Kakuchi.
  7. Investing

    UPS Stock: An Earnings Case Study

    Check out the analysis of earnings for United Parcel Service, including historical earnings, past analyst estimates and future analyst estimates.
  8. Mutual Funds & ETFs

    VWEHX: Vanguard High-Yield Corporate Fund Performance Case Study

    Review the performance trends of the Vanguard High-Yield Corporate Fund, and learn which times of year the fund has performed at its best and worst.
  9. Investing

    Disney Stock: An Earnings Case Study (DIS)

    Explore an earnings case study of The Walt Disney Company, and learn about its earnings and revenue in 2014 and 2015 and what analysts expect for Disney in 2016 and 2017.
  10. Investing

    UPS Stock: Analyzing 5 Key Suppliers

    Learn about the businesses and financial profiles of five key suppliers to UPS. Discover how much of each company's business is dependent on UPS.
RELATED TERMS
  1. Bunny Market

    Bunny market describes a stock market that does not have an obvious ...
  2. Davos Man/Davos Woman

    Davos man/Davos woman refers to the members of the World Economic ...
  3. File and Suspend

    File and suspend is a Social Security claim strategy that allows ...
  4. Form 1095-B

    An IRS Form sent to individuals who received minimum essential ...
  5. Form 1095-A

    An IRS form sent to anybody who received health insurance coverage ...
  6. Kurtosis

    A statistical measure used to describe the distribution of observed ...
RELATED FAQS
  1. Is a money market account the same as a money market fund?

    Discover the differences between money market accounts and money market funds, including minimum balance requirements, withdrawal ... Read Answer >>
  2. What is the 1003 mortgage application form?

    Learn about the 1003 mortgage application form, what information it requires and why this form is the industry standard for ... Read Answer >>
  3. What typically comprises a money market fund?

    Learn about the basic types of money market funds and discover how they are characterized by the types of investments that ... Read Answer >>
  4. How can I budget for both short-term expenses and long-term goals?

    The first step in planning for long-term goals is actually determining how much you spend on short-term expenses. Once you ... Read Answer >>
  5. What are common advantages of investing in large cap stocks?

    Learn what large-cap stocks are and how investors can benefit from common advantages of adding large-cap stocks to their ... Read Answer >>
  6. How old should you be to get life insurance?

    There's really no pre-determined age when it suddenly becomes necessary to take out a life insurance policy. However, if ... Read Answer >>
Hot Definitions
  1. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  2. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  3. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  4. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  5. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  6. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
Trading Center