5 Types of Investment Risk Every Investor Should Know
Published on April 28, 2025
When most people think about investment risk, they often focus solely on the possibility of losing money in the stock market. However, investment risk comes in many forms, and understanding these different types can help you build a more resilient portfolio. Here are five key types of investment risk that every investor should be aware of.
1. Market Risk
What it is: Also known as systematic risk, market risk refers to the possibility that the value of an investment will decrease due to changes in the overall financial markets. This type of risk affects nearly all investments to some degree.
Examples: Stock market crashes, sector-wide downturns, or broad economic recessions.
How to manage it: Diversification across different asset classes (stocks, bonds, real estate, etc.) can help mitigate market risk, as can maintaining a long-term investment horizon that allows you to ride out market fluctuations.
2. Inflation Risk
What it is: Inflation risk, or purchasing power risk, is the risk that the value of your investment returns won't keep pace with inflation, effectively reducing your purchasing power over time.
Examples: A "safe" investment that returns 2% annually during a period of 3% inflation is actually losing purchasing power.
How to manage it: Invest in assets that historically have outpaced inflation, such as stocks, real estate, or Treasury Inflation-Protected Securities (TIPS).
3. Interest Rate Risk
What it is: Interest rate risk refers to the potential for investment losses due to changes in interest rates. This primarily affects fixed-income investments like bonds.
Examples: When interest rates rise, the value of existing bonds typically falls, as newer bonds offer higher yields.
How to manage it: Consider a ladder strategy with bonds of varying maturities, or invest in floating-rate securities that adjust with changing interest rates.
4. Liquidity Risk
What it is: Liquidity risk is the risk of not being able to buy or sell an investment quickly enough to prevent or minimize a loss, or not being able to access your funds when needed.
Examples: Real estate investments, certain alternative investments, or stocks with low trading volumes can be difficult to sell quickly without accepting a significant discount.
How to manage it: Maintain an emergency fund in highly liquid assets, and be mindful of the liquidity characteristics of your investments, especially for funds you may need in the near term.
5. Credit Risk
What it is: Credit risk, or default risk, is the possibility that a borrower will fail to repay a loan or meet contractual obligations, resulting in losses for the lender or investor.
Examples: Corporate bonds carry the risk that the issuing company might default on interest or principal payments.
How to manage it: Invest in bonds with higher credit ratings, diversify across multiple issuers, or consider bond funds that spread credit risk across many different bonds.
Understanding your personal risk tolerance is key to managing these different types of investment risk. Take our risk tolerance quiz to discover which types of risk you're most comfortable with and which you might want to minimize in your portfolio.
Balancing Risk in Your Portfolio
Every investment carries some form of risk, and different investments are subject to different types of risk. Understanding these various risk factors can help you build a more balanced portfolio that aligns with your financial goals and personal risk tolerance.
Remember that risk management isn't about eliminating risk entirely—it's about taking calculated risks that you understand and are comfortable with, given your financial situation and goals.