Investment risk refers to the potential for an investment’s actual returns to differ from its expected returns. There are several components that contribute to investment risk. While the specific categorization might vary, here are five common components of investment risk:

Market Risk (Systematic Risk): This risk arises from factors that affect the entire market or a specific segment of it. Market risk includes events like economic recessions, interest rate fluctuations, political instability, and global events that can impact the overall market. It cannot be diversified away through portfolio diversification because it affects the entire market.

Interest Rate Risk: Interest rate risk pertains to the impact of changes in interest rates on an investment’s value. Generally, when interest rates rise, the value of fixed-income securities such as bonds tends to fall, and vice versa. This risk is especially relevant to fixed-income investments.

Credit Risk: Also known as default risk, credit risk refers to the possibility that the issuer of a bond or other debt security might not fulfill their payment obligations. This risk is more prominent with lower-rated or high-yield bonds, as there’s a higher likelihood of the issuer defaulting on payments.

Liquidity Risk: Liquidity risk relates to the ease of buying or selling an investment without significantly affecting its price. Investments that are less liquid can experience wider bid-ask spreads and potential difficulty in finding buyers or sellers. This risk is particularly pertinent when dealing with less-traded securities or during periods of market turmoil.

Inflation Risk: Inflation risk, also known as purchasing power risk, arises from the erosion of the real value of investments due to inflation. When the rate of inflation outpaces the return on an investment, the purchasing power of the investment’s returns decreases over time. This is particularly important for investments that don’t keep pace with inflation, such as some conservative fixed-income assets.