Risk and return: an introduction

Every investment has risks. Below are definitions of the types of investment risks, in alphabetical order.


 * Credit Risk--the risk of default. Holders of bonds face this risk.


 * Currency Risk--the risk due to changes in exchange rate. Investments in currencies other than the one in which you purchase most goods and services are subject to currency risk.


 * Inflation Risk--the risk that one's investment will not keep pace with inflation. This risk can be mitigated by investing in inflation protected Treasury bonds or other assets thought to rise with inflation.


 * Interest Rate Risk--the risk associated with changes in asset price due to changes in interest rate. Bonds and bond funds face this type of risk. As interest rates rise, prices on existing bonds decline and vice versa.


 * Longevity Risk--the risk you will outlive your money.


 * Management Risk--the risk that fund or portfolio managers will under-perform benchmarks due to their management decisions or style. Active funds face this risk. Investors can avoid this risk by selecting index funds.


 * Market Risk--the systematic risk faced by all equity investors due to market volatility. This risk can not be diversified away. This is the type of risk most people are referring to when they casually use the term "risk" with respect to investments, without qualification.


 * Political Risk--the risk to an investment due to changes in the law or political regime. Potential changes in tax law or changes in a country's structure of governance are sources of political risk.


 * Under-performance Risk--the risk your portfolio will not provide sufficient returns to meet your goal(s). Stuffing your cash under your mattress is associated with this type of risk.

See also Risk, Uncertainty, and Behavioral Pitfalls