You should carefully consider your risk tolerance, time horizon, and financial objectives before making investment decisions. By investing, you run the risk of losing money or losing buying power (where your money does not grow as fast as the cost of living). Risk can be classified into many different categories, and by knowing those categories you can better manage expectations and avoid or reduce certain kinds of risk.
General Investing Risks
For even more information about investment risk, see FINRA’s page about Managing Investment Risk.
Market risk (also known as systematic risk) generally affects most or all securities in the marketplace, which means that this risk cannot be fully diversified away. Some common factors that broadly affect securities are changes in interest rates, inflation, currency exchange rates, and the political and economic environment. In the short term, security prices can fluctuate dramatically in response to these developments. Different companies and different asset classes (such as cash, bonds, and equities) can react differently to these developments. The worst effects of market risk can be avoided by investing across asset classes that tend to perform differently under the same market and economic factors and investing over a long-time horizon.
Nonsystematic risk affects a narrow group of securities that are closely related in sector, business, or product. Nonsystematic risk is intensified when investing in only one company, or being overly concentrated in one company. The performance of that company is not only affected by broad market risk, but also by managerial risk (such as poor strategy or management) and other company-specific factors that may cause the company to underperform while the industry or sector of that company actually outperforms. Investing in one sector reduces company-specific risk, but nonsystematic risk remains in that a social or political development can greatly impact the sector and not the broader market (such as a change to tobacco regulations). The worst effects of nonsystematic risk can be avoided by investing across sectors that have different revenue sources. The effects of nonsystematic risk can be reduced further by investing across asset classes that tend to perform differently under the same market and economic factors.
Risks of Investing In Different Assets
Inverse and Leveraged ETFs
The Securities and Exchange Commission (SEC) and FINRA, the organizations that regulate the securities industry, issued an Investor Alert on June 31, 2009 advising retail investors of the risks associated with “leveraged and inverse ETFs.” Specifically, they warn that by design, these instruments tend to deviate from—and may underperform relative to—their benchmarks for periods longer than one trading day. These deviations may be substantial for longer periods.
What are inverse and leveraged ETFs?
Leveraged ETFs are securities that attempt to replicate multiples of the performance of an underlying financial index. Inverse ETFs are designed to replicate the opposite direction of these same indices, often at a multiple. These ETFs often use a combination of futures, swaps, short sales, and other derivatives to achieve these objectives.
Why don’t they track their indices well over longer periods of time?
Most leveraged and inverse ETFs are designed to achieve these results on a daily basis only. This means that over periods longer than a trading day, the value of these ETFs can, and usually do, deviate from the performance of the index they are designed to track. Over longer periods of time or in situations of high volatility, these deviations can be substantial.
What You Should Know
Customers should carefully evaluate leveraged and inverse ETFs by looking closely at their prospectuses and considering their own financial goals and risk tolerance before investing in these securities. Buy-and-hold investors should be particularly cautious when evaluating these investments, because they may not track their underlying indices over longer periods of time and may have additional risks inherent to the nature of their underlying assets. Even experienced retail investors should reflect carefully before retaining these securities longer than one trading day.
Foreign Investment Risk
Foreign securities, foreign currencies, and securities issued by U.S. entities with substantial foreign operations can involve additional risks relating to political, economic, or regulatory conditions in foreign countries. These risks include fluctuations in foreign currencies; withholding or other taxes; trading, settlement, custodial, and other operational risks; and less stringent investor protection and disclosure standards in some foreign markets. All of these factors can make foreign investments, especially those in emerging markets, more volatile and potentially less liquid than U.S. investments. In addition, foreign markets can perform differently from the U.S. market.
There are risks associated with investing in an initial public offering (IPO). Investors should read the offering prospectus carefully and make their own determination of whether an investment in the offering is consistent with their investment objectives, financial situation, and risk tolerance.
The SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin providing investors with information they should consider when investing in the shares of a new public company. For more information, read the SEC’s Investor Bulletin on Investing in an IPO.
Inflation Risk: The risk that the value of an account, including interest, does not keep pace with inflation, thus reducing purchasing power.
Fixed Income Investing Risk
The chance that an investor will not be able to sell bonds at desired prices and that large purchases or sales of bond issues may cause substantial price swings.
Interest Rate Risk
Interest Rate increases (decreases) can cause the price of a debt security to decrease (increase). Longer-maturity bonds typically incur more extreme price changes based on changing interest rates than those bonds with short maturities.
Credit Risk Types
- Downgrade Risk: The chance that bonds will have their credit ratings reduced, which could reduce the future income expectation of the bond. Specifically, companies issuing high-yield bonds are generally not as financially strong as companies rated investment grade.
- Default Risk: The chance that a bond issuer will fail to make its scheduled interest or principal payments.
- Credit Spread Risk: The chance that the market value of a bond will decline and/or the price performance of a bond will be worse than that of other bonds. An example would be the yield premium between Treasury bonds and non-Treasury bonds where the spread can increase with the Treasury bond price going up and the market price of the non-Treasury bond declining.
Risks of Investing In Folios
Since folios contain individual securities that rise and fall in value, the value of your folios will also rise and fall in value. You can lose money even if you are well-diversified. When the stock market suffers widespread declines even well-diversified and extremely conservative investments are likely to fall in value. Additionally, exchange-traded funds (ETFs), mutual funds, and American depositary receipts (ADR) included in a folio are subject to risks similar to those of stocks. Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost.
Risks of Online Investing
On occasion things can go wrong and you need to be prepared. For example, computers can crash and orders to buy or sell securities can pile up at the marketplace where an order is to be executed.
While we have put significant resources into building and testing our computer systems, you should expect that computer glitches, slowdowns, and crashes may occasionally occur.
We cannot guarantee that you will always be able to access our website or place the trades you want, when you want to, or that any marketplace we send orders to for execution will be able to handle those orders in a timely way.
Because we are not liable for any damages or losses that you suffer if you cannot get access to our website, make sure that you are prepared to handle the problems we have described here and others described in your customer agreement as these are risks that you bear.
Risks of Self-Directed Investing
As a user of our website you are acting as a self-directed investor. With that in mind remember that we do not review your financial situation or tolerance for risk, nor do we determine if the folios, securities, strategies, or tools you use to select folios, securities, or investment strategies will result in suitable or profitable investments for you. When we make available initial public offerings or private placement offerings on our website, we are not evaluating the merits of any of those offerings. We do not make recommendations of either securities or investment strategies to you personally and nothing on this website should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or strategy by folio unless specifically labeled as such. We also do not provide legal or tax advice. You must make all investment, legal, and tax decisions without assistance from us.
You alone are solely responsible for determining whether any investment, security or strategy, or any other product or service available on our website, is appropriate or suitable for you based on your assessment of your investment objectives and personal financial situation. You should consult an attorney or tax professional regarding your specific legal or tax situation.