What is Market Risk: Its Types, Influencing Factors, and Much Moreē
We have all heard the disclaimer: "Mutual funds are subject to market risk." It appears at the bottom of ads, flashes briefly on screens, and is largely ignored as background noise. But what does market risk for investors actually mean, and why does it matter so much? Market risk explains why investments go up and down, sometimes in unexpected ways. It's determined by a set of investment risk factors that no one individual or firm can completely control. Being aware of this risk helps you make wiser, more sure decisions with realistic expectations.
Whether you are a beginner in investments or a seasoned individual, it is necessary to know how market risk affects investments. In this guide, we will help investors understand what drives financial market risk and how to handle it wisely. So, let’s get started!
What is Market Risk?
Market risk in investing refers to the idea that the value of an investment will go down because of changes in the market. Market risk is known to affect every player in the financial market, not just a single investor or an organization. This makes it even more important for every individual involved to understand how risk and return work.
Once you start understanding market risk, you will be able to:
- Make better investment-related decisions
- Be prepared for losses
- Stay informed about what's happening in the economy
Types of Market Risks
Now that you have understood what market risk is, let us have a look at the different types of risks for investors:
- Equity Risk: Equity risk refers to the possible losses from fluctuating stock prices due to volatility in the market. It could affect investments in equities, such as stocks and equity mutual funds.
- Interest Rate Risk: Interest rate risk reflects the potential impact on bond and fixed-income investments because of changes in interest rates. When rates go up, the value of existing bonds goes down, and when rates go down, existing bonds become more attractive relative to newly issued debt instruments.
- Commodity Risk: Commodity risk refers to the type of risk involving any potential losses due to changes in the prices of metals, energy sources, and other agricultural products.
- Currency Risk: The risk associated with the constant fluctuation in foreign exchange rates, which may decrease returns upon conversion back into the investor's home currency, is known as currency risk or exchange rate risk.
Primary Factors Impacting Market Risk in Investment
Following are the key investment risk factors each investor should be aware of:
Changes in Interest Rates:
Central banks such as the Reserve Bank of India raising interest rates increases borrowing costs, slows the economy, and reduces existing debt investments' value.
Political Factors:
The following political developments tend to imply higher market risk:
- Elections
- Changes in policy
- Government instability
Geopolitical Factors:
Policy changes directed at the economy, foreign sanctions, wars and other global affairs can lead to foreign exchange market volatility and exposure to currency risk on the worldwide level.
Natural Disasters:
Earthquakes, floods, or pandemics are some other sources of market volatility.
Technological Innovation:
Quick tech shifts can create more efficient companies but can also disrupt industries and make stock prices decline, adding to the risk in financial markets.
Conclusion
Understanding the different types of market risks along with the factors influencing them can help you make smarter investment decisions. Together, these market risks highlight the different ways in which your investments can be affected by changing economic and financial conditions. Of course, each risk type and factor works differently, but once you have understood how to tackle them through the right strategies to reduce market risk, you will be able to safeguard your investments.
When you monitor interest rates and exchange rates, maintain liquidity, have a focus on long-term investment goals, and use Systematic Investment Plans, you also have a better opportunity to manage market risk and return balance while also protecting your investment portfolio from losing value.