Learn About Investing #4: What is Risk?

Summary

In this video, we explore the concept of risk in investing. Risk is defined as the possibility of loss or injury, using everyday examples like driving to explain its significance. The video outlines how risk can increase in probability and severity, and introduces various types of risks, such as credit, currency, and market risks. Credit risk is discussed in more detail, focusing on how a borrower's ability to repay debt affects potential losses. The next video will delve deeper into the risk of losing money through different types of investments.

Takeaways

• 🧐 Risk is the possibility of loss or injury, which applies to both everyday life and investing.
• 🚗 An example of general risk is driving fast and weaving through traffic, which increases the chances of an accident and its severity.
• 📉 In finance, risk can increase in two main ways: the likelihood of loss or injury, and the potential severity of that loss.
• 📊 There are different types of risks in investing, such as credit risk, currency risk, interest rate risk, reinvestment risk, political risk, inflation risk, longevity risk, and market risk.
• 📚 Some of these risks are more advanced and don't need to be fully understood in early stages of learning about investing.
• 💳 Credit or default risk is the possibility that a borrower cannot repay a loan as scheduled.
• 💼 A person's credit score is a measure of their likelihood to repay debt, with higher scores representing lower credit risk.
• 📉 The nature of credit risk can range from small (a missed payment) to severe (bankruptcy).
• 🧐 Risk in investing is primarily about the risk of losing money, with varying levels of potential losses and frequency.
• 🔍 The next part of the series will focus on how risk specifically relates to different types of investments.

Q & A

What is the general definition of risk?

Risk is the possibility of loss or injury.

How does the car driving example explain risk?

The car driving example illustrates that by speeding and weaving through traffic, the risk of getting into an accident increases. Similarly, in investing, higher risk can lead to greater losses.

What are two ways in which risk can increase?

Risk can increase if the possibility of loss or injury goes up or if the potential severity of the loss or injury increases.

What are some types of risks commonly associated with investing?

Some common types of risks in investing include credit or default risk, currency risk, interest rate risk, reinvestment risk, political risk, inflation risk, longevity risk, and market risk.

What is credit or default risk?

Credit or default risk is the risk that a borrower will not be able to make their scheduled repayments, either missing a payment or going bankrupt.

How is the probability of credit risk determined?

The probability of credit risk depends on factors like the borrower's assets, income, job stability, and existing debts. A borrower with high assets and income is less likely to default, while someone with significant debts and an unstable job is more likely to miss payments.

How does a credit score relate to credit risk?

A credit score reflects the borrower's perceived risk to lenders. A higher credit score indicates less risk, while a lower score suggests a greater risk of default.

What happens to a borrower’s credit score if they miss payments?

If a borrower misses a payment, their credit score may drop slightly. If they miss multiple payments or default entirely, their score can drop significantly.

Why is understanding risk important for investors?

Understanding risk is crucial because different investments carry varying levels of risk. Being aware of the potential for loss helps investors make informed decisions about where to put their money.

What will the next video in the series focus on?

The next video will focus on risk in the context of investing, particularly the risk of losing money in various types of investments.