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Consider Market Risk When Making Investments

When making investment decisions, it is important to consider both specific and market risk. Market risk can play a significant role in whether an investment is ultimately successful. The importance of market risk is illustrated by a recent Financial Industry Regulatory Authority (FINRA) investor alert re-issue, which advised investors to consider market risk along with the risks associated with a specific investment or asset class. A financial advisor’s failure to consider market risk frequently leads to claims for negligence, breach of fiduciary duty, portfolio mismanagement and overconcentration.

What is Market Risk?

Market risk, also called “systematic risk,” is the risk of investment loss due to factors that impact the overall performance of the financial markets. In contrast, specific risk (also known as unsystematic or business risk) is the risk of loss that is directly related to the performance of a particular security, product, company, or industry sector.

Market risk involves factors or variables that impact the overall economy or securities markets. When these factors cause the overall market to decline, the value of an individual investment in a company also declines, regardless of that company’s growth, revenues, or earnings. As a result, diversification provides less protection against market risk than it does for specific risk. However, diversification is still important. This includes investing in diverse products, regions (domestic v. foreign), and holding periods (short v. long term).

Some Examples of Market Risk

There are many types of market risks, such as a major natural disaster, economic recession, or political instability. Additionally, market risk includes the following:

  • Interest rate risk: changes in the interest rate can reduce the value of a security. Bonds are particularly susceptible to this risk. When interest rates increase, the price of bonds decreases and vice versa. The risk exists because as interest rates increase, greater yields can be obtained by switching to a different investment that reflects the new, higher interest rate.
  • Inflation risk: when inflation causes the cost of goods and services to increase, it reduces the value of money, which also negatively impacts the value of investments. Inflation is also closely tied to interest rate risk, as, generally speaking, interest rates increase with inflation.
  • Sociopolitical risk: this risk includes political and social events like terrorist attacks, wars, or elections. These events often impact the attitudes of investors toward the market, which can cause fluctuations in stock prices.
  • Liquidity risk: not being able to buy or sell investments quickly at a price that reflects the true underlying value of the asset. If there are no buyers, an owner will not be able to sell and by the time a buyer does come along, the asset or instrument may not be worth anything.

Securities Law Attorneys

With knowledgeable and thoughtful investment advice, the danger of market and specific risk can be lessened. However, when you believe that your stockbroker has committed misconduct in advising you, it may be possible to recover damages for your losses. For more information, speak with an attorney with experience in securities arbitration and investment fraud today. We look forward to hearing from you.

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