Personal Finance

Investors face many kinds of risks:

Exogneous Risks – Risks that are external and common to all investors
1. Market risk – Risk which is common to an entire class of assets
2. Interest rate risk – Risk that value will change due to a change in interest rates
3. Reinvestment risk – Risk that future proceeds will have to be reinvested at a lower interest rate
4. Business risk – Risk associated with the unique circumstances of a particular company
5. Liquidity risk – Risk that security cannot be sold quickly
6. Default risk – Risk that company or individual will not be able to meet contractual obligations.
7. Industry risk – Risk which is common to a specific industry
8. Deflation risk – Risk of contracting (vs inflating) volume of money and credit relative to available goods. Considered the most dangerous risk to an economy because consumers stop spending and hoard cash. This triggers a vicious cycle of increasing unemployment and declining economic activity which is difficult to reverse.
9. Inflation risk – Risk of expanding (vs. deflating) volume of money and credit relative to available goods. Also called “purchasing power risk”.
10. Uncompensated risk – Risk for which the investor receives little or no reward because the risk can be diversified away.

Endogenous Risks – Risks that are internal and specific to the individual investor
1. Longevity risk – Risk of outliving your money
2. Unemployment risk – Risk of no income
3. Morbidity risk – Risk of disability or need for long term care
4. Mortality risk – Risk of premature death
5. Cash flow risk – Risk of insufficient cash to meet living expenses
6. Default risk – Risk of not being able to meet contracted financial obligations
7. Decision making risk – risk of suboptimal decisions triggered by emotions, lack of knowledge, bad information or bad advice from media or incompetent advisors. Evidence suggests this is the greatest risk faced by investors.
8. Fraud risk – Risk of being defrauded by criminal activity of advisor (Madoff, etc.)

The three Commandments for Successful Investing
1. Thou shall not take any risk that thee dost not need to take
2. Thou shall not take any risk for which there is not commensurate reward
3. Thou shall not risk any money thee cannot afford to lose.