Understanding Risk vs Return in Investing

Liquidity risk is the risk that investments cannot be converted to cash easily and quickly. Investments like real estate or ELSS (Equity-Linked Savings Scheme) have low liquidity as they cannot be easily and immediately converted to cash.

Market risk is the possibility of the markets moving downwards. Market risk includes the risk of unfavorable changes in stocks, currency, and interest rates in the markets.

Specific risk refers to the financial issues and risks associated with a company. Investors track a company’s financial performance frequently and diversify their investments so negative performance of one investment does not bring down the whole portfolio value.

Credit risk is the counterparty risk where a borrower or company is unable to repay the borrowed funds. Credit risk is faced by lenders who invest in corporate bonds, where a company may default on the loan. To combat credit risk, investors invest in financially strong companies that can fulfil their obligations without delay.

When the central banks hike up the interest rates, it increases the cost of borrowing for companies. But it’s favourable for investors looking to invest in currencies. But both face interest rate risk due to changes in interest rates in an economy.

Inflation risk is the decreasing value of your money, which reduces the value of your investments. Inflation erodes the purchasing power of your money. Investors strive to invest in assets that can keep up with the increasing inflation and beat inflation.

Capital appreciation is the growing value of your investments. For example, when you invest in real estate, after a few years, the value of your properties rises either due to inflation or urban development. This increase in value is called the ‘Capital Appreciation.’

When you invest in dividend-paying stocks, the companies regularly share a portion of their profits with their shareholders. This dividend can be an additional stream of income for the investors.

When you buy bonds, you get regular interest payments for lending the money to a company or government. The interest rates vary across different companies, companies with bad credit ratings offer higher interest rates, while government bonds offer low interest returns.

When you invest in real estate, you can put up your properties for rent and earn a regular income.

In currency trading, traders generate profits by trading various currencies. Returns are generated by taking advantage of the difference in the exchange rates between different currencies.