Finance

Fact-checked

What is Financial Risk?

Malcolm Tatum

Last Modified Date: February 22, 2024

Financial risk is the amount of chance that is present with any type of financial investment. Typically, the goal is to secure investments that appear to have a low amount of risk since these are more likely to earn a return. Both individual and corporate investors access the degree of risk present before executing an order to buy shares on any investment market.

Shareholders usually investigate the degree of financial risk present in any investment deal by exploring both the current and past performance of the stock option. The shareholder will also consider any changes in the current financial climate that could either cause the option to increase dramatically in value or cause the option to drop. Knowing this detail will help the investor determine how owning the option will affect his or her overall financial stability.

When purchasing stock, a buyer assumes financial risk because the share value may drop below purchase price.

Corporations also engage in the process of assessing financial risk. In terms of property purchases, there is attention given to the ability to build up equity in the acquisitions, or how to make the most of equity financing strategies. The company will also want to maintain an adequate cash flow, so that even if the acquisition does not appreciate as quickly as projected, the finances of the business remain stable.

A risk analyst, also known as a risk manager, identifies risk or risk behaviors through the help of actuarial tables and other helpful information.

As part of competent financial management, the investor will often project both a best case and a worst case scenario. With the best case scenario, the object is to assess the maximum possible return on the investment within a given amount of time. The worst case scenario will focus on a possible loss of most or all of the investment, including how an event of this type would impact cash flow or hinder the investor from meeting all current financial obligations.

What is considered to be an acceptable level of financial risk will vary from one investor to another. Some investors prefer to focus on acquiring financial instruments such as stocks or bonds that have a very low amount of risk. While the returns tend to be modest, they are consistent and considered relatively safe. Other investors choose to go with a finance strategy involving the acquisition of more volatile stock options, in the hopes of earning a greater return in a short period of time. In order to do this, they understand that there is a greater degree of risk present, so the opportunity to lose money is more pronounced.

Regardless of the preferences of the investor, it is always a good idea to assess the financial risk before investing in any stock, bond, commodities, money market, or property deal. As long as the investor understands what risks are present and can balance them against the potential rewards, it is possible to make an informed decision on what to purchase and what to avoid.

After many years in the teleconferencing industry, Michael decided to embrace his passion for trivia, research, and writing by becoming a full-time freelance writer. Since then, he has contributed articles to a variety of print and online publications, including SmartCapitalMind, and his work has also appeared in poetry collections, devotional anthologies, and several newspapers. Malcolm’s other interests include collecting vinyl records, minor league baseball, and cycling.

Learn more...

Malcolm Tatum

Learn more...

Discussion Comments

icecream17

February 3, 2011

Crispety -I think that believe it or not a lot of companies find overseas investments to be safer than U.S. investments.

The reason remains in the endless financial regulations that Obama imposes on businesses. The U.S. has the highest corporate tax rate and now a socialized health care bill that will kill businesses.

Bill Gates recently said that if he would have started Microsoft now he would not have been able to do it because of all of the governmental regulations.

I think that is far easier and less risky to invest in a country like Costa Rica then sadly, the United States. The United States has to reduce business taxes and governmental regulations in order for other countries to seek investments in the United States.

I am afraid that currently the business climate is far too risky right now.

Crispety

February 2, 2011

Sunshine31 -I agree that slow and steady is a great strategy to handle financial risk. I know that many companies also look into financial risk management when considering opening an operation in another country.

While the costs can be considerably less to a company, the country has to be politically stable enough for the company to prosper. Countries like Costa Rica and Panama are usually great choices because they had very low taxes, an educated workforce, and a stable government.

I also think that the warm climate doesn’t hurt either.

sunshine31

January 31, 2011

I agree that fixed annuities offer low financial risk investments but they are sort of boring. I prefer looking into the real estate market and buying properties now since many of the markets are undervalued and will eventually come back.

I know that the housing crisis really shed light as to the financial risks of real estate investments, but I feel more comfortable with something tangible like an apartment building or a house that I can rent for additional income.

I always manage my financial risk by obtaining a mortgage that I can easily pay myself in case a renter defaults. This is really the key in determining how much financial risk you can assume.

Too many people got into trouble because they were hoping that they could flip the property quickly for a fast profit.

But these people did not consider what would happen if the property could not sell and did not examine the rental potential of the property.

If you buy something that you can easily afford instead of stretching yourself so thin financially it offers you an opportunity to hold on to your investments until the market gets better without the fear of not being able to pay your bills.

I only hold one mortgage at a time so regardless of my tenants I know I could pay the bills. While this may not be as exciting as owning a slew of properties at one time it is the best way for me to manage my financial risks in real estate.

latte31

January 29, 2011

Managing financial risk is important for investors and companies alike. Diversifying your portfolio is the only way to truly manage your financial exposure.

There are many investments that are recommended for those with a longer investment horizon and other investments that allow the capital to remain safe while earning modest gains for those with a shorter investment timeframe.

For example, a person nearing retirement age might consider a fixed annuity for their cash holdings rather than leave the funds in a savings account. This allows the money to grow at a fixed rate for a certain amount of time and that will allow growth without too much risk.

Many investment firms can provide a print out of hypothetical scenarios that determine what the projected growth will be in five to seven years.

Although the yield offered is only a few points above what a bank would offer for a savings account, many seniors feel comfortable with this type of financial risk.