In investing terms, risk indicates the variability of returns associated with investing over time. In other words, the more an investment’s returns go up and down over time, the more risky it is said to be. This is because, as an investor, the more your investment returns fluctuate over time, the less certain you will be about what you can expect to get in future. Greater uncertainty means that there is a greater likelihood that you could get poor returns from your investment or potential to earn significant returns.
While there are many factors that affect the riskiness of an investment, these can be broadly grouped into three categories:
1. Market Risk – This is the risk that unexpected economic, political or other conditions could affect the returns that can be made on the various investments in the market. For example, political instability, the level of economic growth, Government policy, inflation and the level of interest rates can all affect the returns on the various investments in the market. Market risk affects all investments to varying degrees.
2. Industry Risk – Industry risk relates to a particular segment, or industry, within the overall market. For example, if the prices of garments fell in international markets, the performance of local garment manufacturers which export garments would tend to be negatively affected. A likely result of this is a fall in the share prices of companies operating in the garment industry.
3. Specific Risk – Specific risk relates to the performance of a particular investment. For instance, the return on a particular share will depend on the company issuing the share. A profitable company will have a better chance of paying dividends on its shares and generating capital growth than a loss-making company. Therefore, the shareholders in that company are exposed to the quality of the company’s management, processes, workers and other resources, all sources of specific risk.