Risk: The Many Faces of Investing

By Ravi Mittal, Partner at Aurivox Financial Services

When most people hear the word risk, they immediately think of losing money. But in the world of investing, risk wears many faces. Some are obvious, like market crashes, while others work silently in the background, quietly eroding your purchasing power.

There is no investing without risk and understanding the risk-reward ratio of each product is, therefore, one of the foundational pillars of a good financial plan.

Understanding these risks is not about fear — it’s about awareness and preparation. A well-informed investor can manage risk, but an unaware one is often at its mercy.

So let’s try and understand what are some of the key risks our investments are subject to categorised by their nature and impact.

1. Market Risk.

Affects – Any investment, but not simultaneously

This is the broad risk that affects all investments — the tide that lifts or sinks every boat. Events such as the COVID-19 crash, geopolitical conflicts, or inflation spikes can send markets tumbling regardless of how diversified a portfolio is.

Mitigation Strategy: While it can’t be eliminated, market risk can be managed through strategic asset allocation, patience, averaging and staying invested through cycles.

2. Specific Unsystematic Risk

Affects – Equity, real estate, precious metals

Unlike market risk, this one is within an investor’s control. It stems from factors unique to a company, sector, or theme — such as management missteps, adverse policy changes, or business downturns. Overvaluation could be another reason why the risk on an investment goes up significantly. Sometimes the price move is more than warranted and can create a bubble.

Mitigation Strategy: Diversifying across asset classes, sectors, and fund houses helps reduce the impact of such risks on an overall portfolio.

3. Interest Rate Risk

Affects – Fixed Income Investments

Interest rate movements directly influence bond and debt fund performance. When rates rise, the prices of existing bonds typically fall, and vice versa. The longer the bond’s duration, the more sensitive it is to these movements.

Mitigation Strategy: Investors can manage this risk by choosing a mix of short-duration, floating-rate, or dynamic bond strategies aligned with their specific time horizons.

4. Inflation Risk

Affects – Fixed Income Investments and cash

This is perhaps the most silent yet persistent threat to wealth. Even if your money appears to be “growing,” it might be losing real value if returns fail to outpace inflation.For instance, a 6% return in a 7% inflation environment effectively reduces your purchasing power.

Mitigation Strategy: Equity, real assets, and inflation-linked investments are your long-term shields. They are essential to ensure your capital grows above the rate of price increases.

5. Liquidity Risk

Affects – Unlisted equity, real estate, illiquid fixed income products

An asset may be valuable but hard to sell when needed. Being "asset rich and cash poor" can be a serious handicap in an emergency. Real estate, unlisted shares, or certain debt instruments often fall into this category.

Mitigation Strategy: Before investing one should be fully aware of the liquidity and holding period, plus having a portion of one’s portfolio in easily redeemable assets such as liquid funds or short-term deposits, helps maintain flexibility without derailing long-term plans.

6. Credit Risk

Affects – Fixed Income products

This refers to the possibility that a bond issuer may delay or completely default on it’s payments. The DHFL and IL&FS defaults are stark reminders that even fixed-income instruments carry risk.

Mitigation Strategy: Opting for high-quality issuers, diversified debt mutual funds, or sovereign-backed securities can help reduce exposure to such events. As a thumb rule, avoid concentrating holdings in any particular fixed income product and it should be spread across multiple issuers.

7. Currency Risk

Affects – Precious metals, international equity and global debt

For investors with global exposure, fluctuations in foreign exchange rates can significantly influence net returns. A weakening rupee can enhance returns on overseas assets, while a strengthening rupee can erode them.

Mitigation Strategy: A thoughtful balance between domestic and international allocations and occasional currency hedging can help manage this volatility.

8. Political and Regulatory Risk

Affects – Nearly all investments, but not simultaneously

Government policy changes, tax reforms, or global sanctions can have wide-ranging and often sudden effects on markets. These events are largely unpredictable but can significantly influence investor sentiment.

Mitigation Strategy: Staying diversified and maintaining an adaptable portfolio strategy helps cushion against such policy shifts.

9. Reinvestment Risk

Affects – Fixed income products

This risk arises when the returns (coupons or maturity proceeds) from an investment must be reinvested at lower interest rates.For example, if you hold a bond yielding 8% and interest rates fall to 6% when it matures, your reinvested capital will earn less — reducing your overall return.

Mitigation Strategy: Debt investors, especially retirees relying on regular income, should pay attention to this and maintain a laddered or staggered maturity structure to manage it.

10. Concentration Risk

Affects – Any form of investing

This occurs when too much of a portfolio is tied to a single asset, sector, or investment idea. Many investors unknowingly build concentrated positions — for instance, through ESOPs, sectoral mutual funds, or real estate-heavy portfolios.While concentration can boost returns in the short term, it magnifies losses when that specific exposure underperforms.

Mitigation Strategy: Diversification across asset classes, geographies, and investment styles remains the simplest and most effective way to manage this.

11. Behavioural Risk

Affects – Any and all investments

Perhaps the most underestimated risk of all is the investor’s own behaviour. Emotional decisions — like panic selling during downturns or overconfidence during rallies — can destroy years of disciplined effort faster than a market crash.

Mitigation Strategy: Instead of looking for “hot tips”, a clear financial plan, guided by rational asset allocation and periodic review, can help investors stay the course even when markets test their patience.

The Takeaway

Risk is not the enemy of investing; it is its constant companion. You can’t eliminate risk, but you can certainly decide which ones to embrace and which to avoid. Smart investing isn’t about escaping uncertainty — it’s about understanding its many forms, managing it, and aligning it with your goals and temperament.

As wealth managers often say, returns are the reward for taking risk — not for avoiding it.