Understanding Investment Risks & Volatility
There are four different types of risk to consider when making your investment selection:
Volatility is the risk we normally associate with stocks or equity type funds because the price of these investments tends to fluctuate according to market conditions. Despite these fluctuations, markets have historically always rebounded. It is important to determine the level of volatility that you are comfortable with when making investment decisions, bearing in mind that over the long-term, typically the greater the volatility of a fund the greater the potential for higher returns.
Interest Rate Risk:
Interest rate risk is the risk associated with guaranteed type investments, like guaranteed investment certificates (GICs) and bonds. When you purchase a GIC for a term of five years with a specific interest rate of three per cent, you’ve locked in that three per cent return for the five year period. During that same period, if interest rates rise to four per cent you’ve missed out on the opportunity to earn the higher rate of interest.
Inflation risk is the risk that your investments and savings will not keep pace with inflation. Inflation risk is a way of measuring the actual purchasing power of your savings in today’s dollars. If we return to the example of the GIC above, which is earning three per cent when the overall rate of inflation in the economy is five per cent, your real return is -2.0 per cent. You are not keeping pace with inflation. Inflation risk applies to both guaranteed and equity type investments.
Currency risk is the risk that arises from the change in price of one currency to another. If money is converted to another currency to make an investment, changes in the value of the Canadian dollar will affect the return when the money is converted back.
It is extremely important that you select investments that have an appropriate risk level based on your individual circumstances. To assess how much risk is appropriate, you should complete an investor profile questionnaire, available through your bank or financial/investment advisor. It is also important to revisit your answers periodically to ensure they remain appropriate.