not achieving the expected returns on investment.

Three scenarios are possible :

• The investment may give a lesser profit than expected.
• The investment may not give any return at all.
• The money invested is lost either partly or fully.

Let us assume that you invested Rupees 10,000 in a stock which you expected to give 30% return, but unfortunately, the price of that particular stock comes down to Rupees 7000 and you lost Rupees 3,000 of your principal amount. This kind of loss can happen in the case of equities and equity-based investments like mutual funds, futures, and options, etc.. Other investments in gold and real estate are also subject to value risk.

In the stock market, the expected volatility in the price of a share determines the degree of risk. For example, if we were to invest in a share where there is a price fluctuation of 10%, it would mean that the price of that share may go up or down 10%. In an attempt to make a 10% profit, you also end up losing 10%. So depending on the level of risk you are prepared to take, your investment can probably give you a high profit or loss.

Whether you have invested in fixed deposits, equity, mutual funds, ULIPs, ETFs, index funds, or derivatives, any financial product has an element of risk. They all have the risk of not overcoming inflation and producing real returns.

Depending upon your type of Investment, there are many ways you could be subjected to risk. Inflation rates fluctuations affect returns from fixed-income investments while commodity prices are affected by fluctuation in their demand and supply. In the case of stock market investments, the returns depend on businesses that function in an environment that is linked to various factors, whether they are within the business or the particular sectors or economy as a whole. Any kind of fluctuation can affect the business positively or negatively. When the change is negative, the profitability of the business is affected and also its prospects resulting in a fall in prices of the stocks.

Types of risks.

Business risk.

To understand business risk, let us take the example of the IT sector. It may face problems if the US were to bring a curb on outsourcing jobs to India. Changes in the environment within which business functions may be adversely affected which results in a fall in the price of the stock. Businesses may also face risks due to shortage or irregular supply of raw materials, machinery breakdown, manpower problems, change in technology, the introduction of new products by competitors, or change in customer preference. There can be a lot of reasons for a business to face the risk that could impact the performance of the business which reflects on the price of the stock.

Businesses relying heavily on credit is another type of business risk called financial risk. Businesses depending on huge loans could find it difficult to bring down their production costs preventing them to expand because a major part of their profits would go into servicing the loans. Another risk that is also a financial risk, is the interest rate risk, where there is a possibility of interest rates going up. When a company has to pay more interest on their loans, bringing down their profitability. We can see here that the stock market and interest rates are related. Another kind of business risk is management risk, which is a risk associated with the under-performance of company management.

Market risks.

Market risks are external risks to a business like political instability, war, natural calamities, inflation, depression, etc. These may create an environment that is not favorable to the smooth functioning of the stock market. Then there is the legislative risk or regulatory risk, wherein is the possibility of the government introducing new laws, which could create a deep impact on the business of the company. Laws bringing regulations or controls on a particular type of industry may be introduced by the government. To give an example, the government may price control the price of certain items which reduces the profits of that company. The profitability of a company can be adversely affected, by the stricter pollution control norms by the government, which is another example.

Competition from new entrants or existing companies is another kind of risk that a business could face. The tariff war among telecom companies recently is an example. These risks are called competitive risks.

Sectoral risks are risks that affect a particular sector. For example, a change where outsourced jobs flow to other countries may affect IT service providers in India. Such risks may affect an entire sector leaving the other sectors untouched.

Because of this, an investor may find it hard to sell his investments as there are no buyers. This is called liquidity risk. It is a risk where an investor may not be able to sell his shares at a good price, but instead, sell them at the prevailing price thereby suffering a heavy loss. The liquidity position of a particular share can change over time, and there is a possibility that a stock that is being traded-in high volumes today, may find no buyers two years from now.

For the investor, there is another risk called Market timing risk, where the possibility of you entering the market at the wrong time, and also dispose of your investments at the wrong time.

In a nutshell.

There is risk in any form of investing because there no certainty. It is just not possible to predict that a share will give a 30% return. We can only say that it has the potential for a 30% return, after taking into consideration the past and present financial performance, and prospects.

How much risk can you withstand?

Now we come to the question of which asset to invest. This depends on how much risk can you take. That is, if the asset you invested falls in price, how long can you hold on. The capacity to withstand losses differs from person to person. It depends on your age, the number of persons in the family, the standard of living, and sources of income. The capacity of risk you can take is something you have to analyze before you start investing, especially when you invest in shares.

Return:

We know about the risk of starting and running a business. While investing money in businesses with such a risky environment, investors expect higher returns as a reward. If the investment has a lower rate of risk, then investors may be satisfied with a lower rate of return. So it is only natural for people to expect higher returns from stock markets when compared to fixed deposits or bonds.

If your risk tolerance is high, then your ability to invest in risky assets is also high.