Financial Risk

Almost every financial decision involves some uncertainty. Financial risk is the possibility that results differ from what you hoped for, usually in a way that costs you money.

Risk takes many forms. Market risk is the chance that investments fall in value because markets fall. Credit risk is the chance that a borrower does not repay what they owe. Liquidity risk is the chance that you cannot sell an asset quickly without accepting a lower price. Inflation risk is the chance that rising prices reduce the real value of savings. For businesses, there are also risks from changing interest rates, exchange rates and customer demand.

Risk and return are closely linked. Investments that offer the chance of higher returns usually carry higher risk. A government-backed savings account may pay 3% with very little risk, while shares might average more over time but can fall by 30% or more in a bad year.

Risk cannot be removed completely, but it can be managed. Common methods include diversifying across different investments, holding an emergency fund, buying insurance, avoiding excessive debt and matching investments to how soon the money will be needed.