Practical Stewardship – Managing Our Investment Risks, Part 1

by Joseph Gerard Romana

The most basic relationship in finance is that between risk and return, the higher the expected return, the higher the risk one assumes in the investment and vice-versa. Stocks, for example, have higher returns than say, treasury bills because stocks’ returns are more volatile than treasury bills.

The reality is risks cannot be eliminated…they can only be managed well at best. Hence, one must have some basic concept of risk management to minimize the likelihood of bad investments. Managing our investment risks as individual investors need not be rocket science. We just need to understand the basic concepts of risk and apply certain common sense approaches to manage them better.

Risk is simply the chance or probability that something expected may not happen. In the context of investments, risk usually refers to either the chance or probability of losing money, not being able to immediately liquidate, i.e. convert into cash the investments made or both. To this extent, 3 of the more significant investment risks are credit risk, market risk and liquidity risk. Credit and market risks are concerned with losing money and liquidity risk is concerned with being unable to immediately convert our investments into cash.

Credit risk is the possibility that people or institutions that borrowed our money may not be able to pay us back. We may think that because we do not lend money directly, we are not subject to credit risk. Such is not the case. When we deposit our money in the bank, it becomes a payable of the bank and a receivable on our end. When we invest our money in government securities, e.g. Treasury Bills and Bonds, we actually lend to the national government. When we invest in commercial papers of established companies like Ayala Corporation, San Miguel Corporation and the like, we are in effect extending credit to them. And whenever we lend money, we are exposed to credit risk.

Market risk is the possibility that we may lose money on our investments due to movements in market factors such as interest rates, foreign exchange rates or market prices of stocks and similar investments. For OFWs, the most important market factor is the foreign exchange rate. When the peso appreciates, i.e. less Php for every unit of a foreign currency, bad news. When the peso depreciates, i.e. more Php for every unit of a foreign currency, good news. The OFW makes or loses money depending on the direction (appreciation or depreciation of the Php) and extent (amount of depreciation or depreciation of the Php) to specific currencies.

Broken Piggy Bank Liquidity risk refers to the possibility we may not be able to liquidate our investments on time, i.e. convert into cash or a usable form of currency. Take for example, real estate investments. It takes several days at the least to sell real estate properties and in most instances, several weeks or months. If we need money now and if we need to sell a property to raise such money, the risk is high we may not be able to immediately have such cash available because real properties are not liquid assets, i.e. easily convertible to cash. Blue chip stocks listed in the Philippine Stock Exchange (PSE) however, can be sold in the market almost immediately because of the efficient and organized transaction system the PSE has. Hence, such investments are deemed to have low liquidity risk compared to real estate investments.
In part 2, we will identify some of the red flags or warning signs to watch out for in specific investments to help us manage the risks better.
Joseph works as a Bank Examiner at the Philippine Deposit Insurance Corporation (PDIC). He also used to work at the Philippine Stock Exchange (PSE) as Market Risk Officer, Fixed Income Securities Trader, and as Stockbroker. Seph is also a resource speaker for his church’s Biblical Personal Finance seminars. On his artistic side, Seph also sings for the band Army of One. He advocates financial literacy among artists and young professionals. He is one of the proponents of Angat Pilipinas Coalition for Financial Literacy.
Photo credit: 401 (K) 2013



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