Investing starts with confidence, when numbers look good, trends feel right, and decisions seem obvious. But beneath the surface, every investment carries layers that don’t show up in the returns alone.
Some investment risks may move in line with the market, while others remain quiet until the timing is wrong. These risks shape outcomes, test patience, and influence decisions in ways that the investors might not always notice early on.
The discussion that follows outlines the types of investment risks you should know and why they matter long after the investment is made.
Market Risk
Market risk, or systematic risk, is the possibility of investment losses due to factors that influence the overall performance of the entire market. This risk cannot be completely eliminated but is manageable through diversification, asset allocation, and hedging strategies.
The market risks usually arise from macroeconomic and geopolitical events such as economic downturns, political instability, natural disasters, changes in interest rates, and changes in investors’ or market sentiment. It affects investments within a particular market, for example, all stocks in a case of stock market crash. The investors use statistical measures, such as Beta, to measure market volatility of different assets.
For example, in 2025, the Indian share markets saw a sharp correction with major indices sliding as the foreign portfolio investors withdrew about USD 13 to 15 billion, approximately ₹1.1 to 1.2 Crore, leading to volatility spiked. Due to this, the Nifty 50 dropped below 24,700-25,100, while the mid and small-cap stocks dropped by 20%. These moves wiped out a significant portion of market value and shook investor confidence, showing how market swings can hit portfolios even when individual fundamentals appear healthy.
Credit Risk
Credit risk or default risk is associated with debt instruments such as bonds and loans. It is the possibility that the borrower, for example, a company or a government entity, might be unable to make timely interest payments or repay the principal amount at maturity, which could lead to a financial loss for the lender or the investor.
The investments with higher credit risk might offer higher returns to compensate the investors for the increased risk. In India, the credit rating agencies, such as CRISIL, ICRA Limited and CARE Ratings Limited, evaluate the creditworthiness of the issuers and their debt instruments, and assign ratings like AAA and BB, which help the investors to measure the level of credit risk.
For example, in FY 2017-18, the IL&FS groups defaults on term deposits, commercial paper and debt led to redemption pressure, among the investors on mutual funds and sell-offs in the debt markets. The group struggled to service around ₹91,000 Crore in debt against assets over ₹1,15,000 Crore. This case shows how credit risk can spread across the investors and creditors.
Liquidity Risk
Liquidity risk is the potential for an investor or an institution to be unable to buy or sell an asset quickly enough without significantly impacting its price or incurring a major loss. This risk becomes visible when buyers dry up, even if the asset itself hasn’t changed.
The assets with high liquidity risk are real estate, corporate or government bonds with long maturities, and small-cap or thinly traded stocks. And the assets with low liquidity risk are cash, T-bills, and blue-chip stocks which are traded on the stock exchanges and have high trading volumes and demand.
When investors are forced to sell illiquid assets, they may have to accept a significant discount, which may result in capital losses. For example, a tightened liquidity condition emerged in parts of the Indian financial ecosystem when the systemic cash flows dried up after the FPIs exited equities in 2025, withdrawing about ₹1.48 lakh crore. It left only fewer buyers that pushed down prices, increasing trading stress.
Interest Rate Risk
Interest Rate Risk is the potential that the debt investment such as bonds, falls when the market interest rates rise, due to the inverse relationship, where older and lower-yield assets become less attractive compared to the new and higher-yield ones. It impacts the bond prices and reinvestment opportunities.
It includes price risk, where the market value drops, reinvestment risk, that is, lower returns on reinvested funds, call risk, which is early repayment risks, basis risk, which is the mismatch between rate changes, and duration risk, that is the price sensitivity to rate changes.
For example, the RBI announced a 50-basis-point repo rate cut and changed its policy, which turned the bond market volatile, in 2022. The 10-year government bond yield moved about 15 basis points in a single session, and ended near 6.29%, which caused sharp price movements in the existing bonds, affecting the fixed-income investors.
Currency Risk
Currency risk is also known as exchange rate risk or foreign exchange (FX) risk. It is the potential that the investors would experience losses due to unfavourable changes in the value of one currency compared to another, such as Rupee vs US Dollar.
It raises concern for investors who hold assets in the international markets, as returns earned in a foreign currency will eventually be converted back to the investor’s home currency.
So, even if a foreign investment performs well in its local currency, the investor’s overall return could be reduced if the foreign currency weakens against their home currency at the time of conversion.
For example, the Indian rupee slid to multi-year low against the US dollar toward the end of FY2025, amid capital outflows and trade pressures. The currency finished the year at ₹89.87 per dollar, about 4.72% down in 2025, which is the worst annual drop in three years. It further went past ₹91 at a point, cutting into the foreign investment returns and increased costs for the companies dealing in dollar related liabilities.
Operational Risk
Operational risk is the danger that losses occur not from markets moving or credit failing, but from internal breakdowns within a company or financial system. It includes flawed processes, weak management, poor compliance, human error, fraud, or technological failures.
Operational risks don’t usually show up in the price charts or yield curves, but they slowly erode value. The operational failures can result in unexpected costs, restatements of earnings, or sudden drops in confidence in the investors, which could drive the stock prices down.
For example, in India FY 2024-25, the NFRA presented significant audit failures at several leading companies, which highlighted weak audit processes and internal controls. It resulted in losses of tens of thousands of crores for India’s financial markets, hurting both investors and creditors.
Risk Management in Investment
Risk management strategies in investment manage risks arising for the investors:
- Mixing assets, not betting on one outcome: If the investors spread their capital across asset classes and industries, it would help in limiting the damage from one underperforming segment, and keep the portfolio safe.
- Structuring investments with intent: The investors should allocate their capital across equities, debt, and other assets based on their goals, timelines, and stability needs to bring discipline to the portfolio construction.
- Understanding risk comfort level: The investors should be clear about the volatility and potential loss they can handle to avoid panic decisions.
- Hedge it: They can use instruments, such as options and futures, to protect themselves from risk.
- Regular portfolio check: The investors should check and adjust their portfolio to bring allocations back to planned levels, or new opportunities.
Diversification to Reduce Investment Risk
The motto of diversification is keeping risk distributed, not concentrated:
- Balancing Asset Distribution: The investors can spread their capital across equities and debt to reduce reliance on a single return driver.
- Sector-Level Spread: They can invest across industries to limit the impact of sector-specific slowdowns.
- Geographical Exposure: The investors can also hold assets across geographical regions to protect their portfolios from country-based economic or policy risks.
- Liquidity Mix: The combination of liquid and less-liquid assets also ensures flexibility during market stress or cash needs.
- Time Horizon Alignment: The inventors can diversify across short, medium, and long-term investments, which can smooth volatility over different market cycles.
Final Takeaway
Every investment carries risk, whether it’s driven by markets, borrowers, liquidity, interest rates, currencies, or internal failures. Some risks don’t always show themselves but shape the outcomes over time. Therefore, understanding how each risk affects the returns will help the investors to plan in a better way, avoid surprises, and build portfolios to handle uncertainty without falling apart.
FAQ‘s
Investment risks include market risk, credit risk, liquidity risk, interest rate risk, currency risk, and operational risk. Each of these affects investments differently, either through price movements, repayment failures, exit difficulties, policy changes, exchange rate shifts, or internal business failures.
Investment risks can be managed through diversification, proper asset allocation, understanding risk tolerance, using hedging tools when required, and regular review of the portfolios to ensure that they remain aligned with financial goals and changing market conditions.
Market risk refers to the losses caused by market movements driven by economic, political, or global factors. It impacts most investments simultaneously and cannot be eliminated completely, though it can be managed through allocation choices and risk-balancing strategies.
Credit risk is the possibility that a borrower fails to pay interest or repay principal on time. It mainly affects debt investments such as bonds and loans, where defaults or poor credit quality can reduce returns and investor capital.
Diversification spreads the capital across assets, sectors, regions, and time horizons. This reduces dependence on any single investment and limits losses when one segment underperforms, while helping to stabilise overall portfolio performance.
