Understanding Market Risk When You Invest

By: Jan Paul C. Ferrer

 

How you can mitigate the different types of risk in your portfolio

When you invest your money, you probably know you’re taking on a certain amount of financial risk. Unlike depositing money in a bank, where it is often insured and can earn a steady amount of interest, investing doesn’t offer financial certainties. You could earn a great deal of money on your investments, but you also face the risk of losing money.

In general, the more financial risk you’re willing to take on in an investment, the greater your chance of potentially earning higher returns. Higher financial risk will also increase the losses you might face on your investments. However, investors also face risks they don’t necessarily get to choose when they’re selecting investments. “Market risk” is one of those.

Defi ning market risk

Market risk refers to financial factors that can impact an overall economy. Market risk can affect the economy of just one country—such as the U.S.—or it can affect international economies, too. Whenever a geographic area faces a widespread recession, governmental change, natural disaster or other major factors, that area’s financial markets will usually reflect the impact.

Generally, some amount of market risk is inevitable with every investment. Even the most experienced investors can’t completely eliminate market risk. However, smart investors may be able to soften their potential financial losses during a down market by diversifying their portfolios and using what are called market risk “hedging strategies.”

First, though, it’s important to understand the typical market risks all investors face.

The 4 most common market risks

When it comes to market risk, you’ll likely hear about these primary factors:

• Interest rate risk: When overall interest rates shift, your investments can be affected, too. Fixed-income investments like bonds tend to be most directly impacted by interest rate changes. If interest rates go down, bond prices typically tend to swing upward. And when overall interest rates go up, bond prices tend to fall. Investors who own a lot of bonds or bond funds can face significant market risk whenever interest rates shift.

• Equity price risk: Equities, or stocks, tend to be riskier than many other types of investments. Equity price risk just refers to the chance that a particular stock will decrease in value after an investor buys it.

• Currency risk: Whenever there’s a significant change in the price of different countries’ currencies compared to each other (their exchange rates), currency risk is an issue. For example, your investment in a European stock might face some losses because the Euro – US Dollar exchange rate changed. Currency risk is always a concern for investors who have international holdings.

• Commodity price risk: Commodities are raw materials, such as corn, crude oil, cotton and steel. These materials are used directly and sold to produce other products. Big price changes in key commodities can affect investors who invest directly in commodities or in companies that rely heavily on these materials. Commodity prices can be affected by a wide range of factors, including severe weather, supply and demand, currency exchange rate, and regulatory changes.

Strategies for reducing market risk

There’s no way you as an investor can completely eliminate exposure to overall market risk. However, there are things you can do to help your portfolio weather any big market moves.

One way is to diversify your investments. Consider putting money into different asset classes (such as equities, bonds, commodities, real assets). Within equities, you can try investing in different industry sectors (such as technology, health care and energy).

You can also diversify by investing in index mutual funds and exchange-traded funds (ETFs) that invest in thousands of different types of companies.

With so many factors to consider, a Financial Advisor can help you sort through the options to develop a diversified investment strategy that reflects your individual risk tolerance and broader financial goals.

The bottom line: The more you understand the basics of market risk, the better you can prepare your investments to face it.

Disclosures

Article by Morgan Stanley and provided courtesy of Morgan Stanley Financial Advisor.

Jan Paul C. Ferrer is a Financial Advisor in Chicago, IL at Morgan Stanley Smith Barney LLC (“Morgan Stanley”). He can be reached by email at janpaul.ferrer@ morganstanley.com or by telephone at 312 312-419-3535

This article has been prepared for informational purposes only. The information and data in the article has been obtained from sources outside of Morgan Stanley. Morgan Stanley makes no representations or guarantees as to the accuracy or completeness of the information or data from sources outside of Morgan Stanley. It does not provide individually tailored investment advice and has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The strategies and/or investments discussed in this article may not be suitable for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a Financial Advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.

Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters. Jan Paul C. Ferrer.may only transact business, follow-up with individualized responses, or render personalized investment advice for compensation, in states where [he/she] is registered or excluded or exempted from registration, https://advisor.morganstanley. com/janpaul.ferrer

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