We know it well: any activity that we choose to undertake every day contains a risk factor. And we know equally well that it is almost never possible to eliminate it. We can only recognize it, accept it, and choose how to deal with it or avoid it by giving up action.
Giving up liquidity brings opportunities and risks
The choice of invest their savings in financial markets is no exception. Giving up the certainty of a current account (which has the disadvantage of yielding almost nothing but has the advantage of not being subject to losses, except that of inflation which erodes purchasing power) offers us the opportunity to make a return, but it also means exposing ourselves to the eventuality of lose the invested capital. It is therefore a question, also in this case, of evaluate the risk and manage it as best as possible.
It is difficult to recognize all the risks
If some of the risks of a financial investment are more easily recognisable, others are less immediately distinguishable. In the third installment of this Guide, Marcellus Messori has already warned that it is unrealistic to imagine that individual savers acquire such expertise as to directly manage their own investment portfolio. It is true. After all, even economists often rely on managers! It is rather fundamental development of financial education which allows you to choose and interact with savings management professionals to be able to make choices that are consistent with the risks you are willing to take and with the investment horizon you propose.
The risks never end
To orient yourself better it is best to start from two considerations. The first is that every financial instrument is a commitment made by the person who issued it to pay sums of money in the future. These sums can be contractually defined (as in fixed income bonds), depend on the occurrence of certain events (as in derivative and structured products), or depend on the dynamics of future profits (as in corporate shares). The credit risk it is precisely the risk that the promises of a specific issuer are not kept. The more risky a financial instrument is considered, the lower its price will be in relation to what it promises.
This means that, if the best scenario occurs, the return will be higher the lower the price at which we purchased it. It is up to the saver to choose whether to be more attracted by the opportunity or feel rather held back by the unknowns inherent in the investment. Faced with this type of risk, purchasing a share of an investment fund managed by trusted professionals allows you to contain its effects thanks to the diversification of investments. But even in this case, it is good to be aware that when a systemic risk, triggered by macroeconomic, geopolitical, or financial instability factors, almost all market segments suffer and the fund's protection may not be enough.
The second consideration is that the prices of financial instruments are by their nature volatile as they express, at any time, a summary of the vision of the future expressed by all market participants. The market risk it refers precisely to sudden changes in that vision following events, news, announcements that change expectations. Of the multiple factors underlying market risk, in addition to the emergence of generalized credit risks triggered by macroeconomic crises and growing uncertainty, what is perhaps less easy to recognize for the less experienced investor is the interest risk, which can affect shares (when interest rates rise, with the same macroeconomic prospects, the stock market tends to slow down or regress to lower values) but above all it affects fixed income securities, as happened when the ECB started to increase rates. If I have a long-term bond purchased when market yields were lower, I need to know that if I want to sell it I will be able to do so at a discount that makes it attractive in the new context, and that this could eliminate the expected return and even get me a loss.
Liquidity risk
Anticipating the possibility, even if remote, of finding yourself needing to liquidate part of the invested portfolio is another aspect that should not be underestimated. And it's good to know that some titles suffer more than others liquidity risk. While it is true that most off-the-shelf instruments can be sold quickly, for some instruments there is a secondary market with few potential buyers or none at all. Caution is a must in the case of investment fund shares, in cases where it may be long and difficult to sell or redeem from the issuer (but the terms of redemption are declared at the time of subscription).
Currency risk
It is also good to guard against currency risk. If we are attracted by the high return of a financial instrument denominated in a foreign currency, we must take into account that the actual return will also depend on how the exchange rate moves. Since an attractive return can be canceled out by a depreciation of the foreign currency, the less risk-averse saver will do well to purchase assets that are hedged against exchange rate risk. Just as he will do well to avoid investing his money in complex instruments that are difficult to understand. There is also a manager risk, and it is always good practice to make sure you invest in instruments you know and entrust your savings to managers known for their skills.
And now there is also climate risk
But the risks, like exams, never end, and in the future we will increasingly have to deal with the climate risk which is a new way of manifesting systemic risk that can reverberate in the financial markets in hitherto unpredictable ways. While the events of the last decade have made us dust off the political risk, i.e. changes in direction of policies and international tensions that originate from decisions of governments, more or less democratically elected.
When an event triggers generalized credit risks and greater uncertainty, the gap between promised returns widens, as happened, with varying intensities, during the 2008-09 financial crisis, and in the first weeks of the pandemic.
