Investing comes with risks. Sometimes those risks are minimal, as is the case with treasury bonds, but other times, such as with stocks, options and commodities, the risk can be substantial. The more risk the investor is willing to take, the more potential for high returns. But great investors know that managing risk is more important than making a profit, and proper risk management is what leads to profitable investing.

Each investment product has certain risks that come with it, while some risks are inherent in every investment. Here are a few to consider.

SEE: Measuring And Managing Investment Risk

Business Risk
Business risk may be the best known and most feared investment risk. It's the risk that something will happen with the company, causing the investment to lose value. These risks could include a disappointing earnings report, changes in leadership, outdated products or wrongdoing within the company. Because of the large amount of possible risks that come with owning stock in a company, investors know that forecasting these risks is nearly impossible.

Purchasing a put option to guard against a large decline or setting automatic stops are the best ways to guard against business risk.

Call Risk
Some bonds have a provision that allows the company to call back or repay a bond early. They will often exercise this right if they have to pay a higher coupon on an existing bond than what they would have to pay at today's interest rates. Although this will not represent a loss of principal, for investors who rely on a certain coupon rate for their monthly living expenses, this can represent a substantial loss of income.

For those who rely on coupon income for immediate living expenses, investing in noncallable bonds, bond funds or exchange traded funds is a solid diversification strategy.

Allocation Risk
Have you looked at your 401(k) lately? You've likely heard that keeping the appropriate asset allocation is essential to managing risk as you move closer to retirement. Moreover, this summer, federal disclosure rules are requiring 401(k) providers to disclose fees associated with investment products.

The younger you are, the more of your portfolio should be allocated to stocks and as you age, bonds will slowly become the dominant investment type. Manage your allocation risk and fees related to investing in your retirement account by investing in a low-fee target date fund. Additionally, ask for the help of a trusted financial adviser if you don't have the knowledge or experience to manage your own portfolio.

SEE: A Strategy For Optimal Stock And Bond Allocation

Political Risk
Investors in commodities like oil understand political risk. When Iran threatened to block the Strait of Hormuz, investors were concerned that the price of oil would become more volatile, putting their investment at risk. The Haiti conflict and terrorist attacks on oil pipelines have caused artificial volatility to enter oil and other commodity markets. Moreover, issues arising in South East Asia pertaining to land claims, as well as the tensions between North and South Korea, have shaken markets in that region.

Socio-political risk is difficult to avoid since most events happen without warning, but having hard and fast exit points as well as hedges are the best way to weather socio-political storms.

Dividend Risk
Dividend risk is the risk that a company will cut or reduce its dividend. This is not only a problem for those who rely on stock dividends to live on during retirement, but when a company cuts its dividend, it often causes the stock to lose value, as those who were holding it for the dividend move to other dividend-paying names.

Reduce the effects of dividend risk by holding a well-diversified portfolio with multiple dividend-paying stocks. If the dividend is the only reason you're holding the stock, sell as soon as is practical after the announcement of the change.

SEE: Your Dividend Payout: Can You Count On It?

The Bottom Line
Every investing strategy will have risks and managing those risks is how to gain the best performance from your money. Don't reach for higher rewards without first evaluating the risks involved. Seasoned investors know that it's a lot easier to lose money than it is to gain it.

Related Articles
  1. Mutual Funds & ETFs

    3 AllianceBernstein Funds that Are Rated 5 Stars by Morningstar

    Discover the top three mutual funds administered and managed by AllianceBernstein that have received five-star overall ratings from Morningstar.
  2. Mutual Funds & ETFs

    Top 4 Davis Funds for Retirement Diversification in 2016

    Discover the four best mutual funds managed by Davis Advisors that pursue different investment strategies that can help diversify retirement portfolios.
  3. Mutual Funds & ETFs

    Top 5 Natixis Funds for Retirement Diversification in 2016

    Discover five mutual funds from Natixis Funds that provide high income, growth and preservation of capital while diversifying a retirement savings plan.
  4. Mutual Funds & ETFs

    Top 3 Allianz Funds for Retirement Diversification in 2016

    Discover the top three Allianz funds for retirement diversification in 2016, with a summary of the portfolio's managers, performance and risk measures.
  5. Mutual Funds & ETFs

    3 PIMCO Funds Rated 5 Stars by Morningstar

    Learn about three fixed income mutual funds managed by Pacific Investment Management Company (PIMCO) that have received five-star overall ratings from Morningstar.
  6. Mutual Funds & ETFs

    3 Invesco Funds Rated 5 Stars by Morningstar

    Learn about the top three mutual funds administered and managed by Invesco Ltd. that have received a five-star overall rating from Morningstar.
  7. Mutual Funds & ETFs

    The Top 4 Russell Funds for Retirement Diversification in 2016

    Discover four mutual funds administered and managed by Russell Investments that would add diversification benefits to a retirement portfolio.
  8. Mutual Funds & ETFs

    Top 3 PIMCO Funds for Retirement Diversification in 2016

    Explore analyses of the top three PIMCO funds for 2016 and learn how these funds can be used to create a diversified retirement portfolio.
  9. Mutual Funds & ETFs

    The 4 Best Lord Abbett Mutual Funds

    Discover the four best mutual funds administered and managed by Lord, Abbett & Co., LLC that offer investors a wide variety of investment strategies.
  10. Mutual Funds & ETFs

    The ABCs of Mutual Fund Classes

    There are three main mutual fund classes, and each charges fees in a different way.
RELATED FAQS
  1. What's the difference between a stop and a limit order?

    Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you ... Read Full Answer >>
  2. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
  3. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  4. Can hedge fund returns be replicated?

    You can replicate hedge fund returns to a degree but not perfectly. Most replication strategies underperform hedge funds ... Read Full Answer >>
  5. Does mutual fund manager tenure matter?

    Mutual fund investors have numerous items to consider when selecting a fund, including investment style, sector focus, operating ... Read Full Answer >>
  6. Why do financial advisors dislike target-date funds?

    Financial advisors dislike target-date funds because these funds tend to charge high fees and have limited histories. It ... Read Full Answer >>
Hot Definitions
  1. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  2. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  3. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  4. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  5. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
Trading Center