The importance of understanding your Investment Risk

Mask on money

Since the advent of the COVID-19 pandemic, life for everyone has changed significantly. For investors it’s a whole new paradigm, and I am sure that many are questioning whether the investment decisions that they have made were the right ones against the background of tumbling financial markets worldwide. It is said that hindsight is 20/20 and many investors wonder if they could have done better. It is said that a good decision is as good as the information that is available when it was made. If investment decisions are made on faulty assumptions /information, then chances are the outcomes will have a high probability of being disastrous.

Understanding risk in general as well as the specific risk associated with each investment is the first step to making the right investment decision. Investors risk some or all of their principal investment. Each investor will have their own risk profile and propensity for risk which is then weighed against the fundamentals of the investment. We are all familiar with the adage: the greater the risk, the greater the return. Time horizons and the liquidity of the investment is often a key factor in influencing risk. The longer the term is, the greater the risk and the harder it is to liquidate compared to a shorter-term investment. Age matters when making an investment and a younger person has a longer time to retirement than an older person. This time allows the younger person to take on a higher level of risk as they have more time to recover in the event of losses. Older investors do not have this luxury, so they have to be more risk averse to protect their principal as they approach their retirement.

Financial risk is divided into two classes viz. systemic and unique risks. Systemic risk is risk associated with the entire market as what has and is happening worldwide as a result of the COVID19 pandemic. There is not much that one can do to avoid such risk, however its effect can be mitigated if proper measures are taken to reduce the unique risk. Unique risk consists of several risks and some of the more important ones are credit risk and country risk to name a few. Credit Risk is important to investors especially those that are invested in fixed income investments such as bonds. Issuers of global bonds have their credit rating assessed by globally recognized rating agencies such as Standard & Poor’s, Fitch, and Moody’s who categorize them in categories including investment grade and junk.

Investment grade issues have a lower probability of default than those in the junk category. This means that those investors who are risk averse -such as older investors, ought to be looking for investments in this category. In recent times we have seen Digicel technically default on their bond obligation and have filed for bankruptcy protection as they come to an agreement with their creditors. This did not occur overnight but would have been triggered by a series of downgrades in their credit rating and outlook. This acts as a trigger for prudent investors that were paying attention to the credit ratings and would not come as a surprise. Chances are they would not have had any position in this investment.

With the current COVID-19 pandemic, now is the time for investors to reassess their investment to see what effect the new market conditions pose for their investment. Can the investment they hold withstand the vagaries of the pandemic? Many industries have suffered setbacks such as airlines, entertainment, sports, and tourism to name a few. Are those entities involved in such industries able to recover and are they able to service their debt obligation? Now more than ever is when particular attention should be paid to rating agencies’ reviews of companies and countries credit rating and outlook. If you are unsure about your investment you should check with your approved investment advisor. It is better to be safe than sorry.

Ian Watson is Vice President, Sales & Marketing at Sterling Asset Management Ltd. Sterling provides financial and advisory services to the corporate, individual and institutional investor. Feedback: If you wish to have Sterling address your investment questions in upcoming articles, please e-mail us at: [email protected] or visit our website at www.sterling.com.jm

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