Other types of risk involve uncertainty and unpredictability. When you make an investment, it can be difficult to say with any certainty what you'll get back when you finally cash it in.

Share prices fluctuate, interest rates vary, and inflation is a risk too. Just concentrating on capital risk and ignoring these other risks can mean you take too cautious an approach.

Understanding risk means identifying your own attitude to risk and identifying the different types of risk. Then you can make a more informed choice and find the most suitable investment to meet your objectives.

Some simple rules:

• The greater return you want, the more risk you'll usually have to accept
• The higher return you want from your investments, the greater the chance of losing some or all of your initial investment (your capital)
• The longer you can wait before you need to cash in your investments, the more risk you can afford to take
• If you're saving over the short-term it's wise not to take much capital risk. So what you are investing for and when you'll need access to your money will have a big impact on what types of investments are right for you
• If you are investing for the long-term you can afford to take more risk
• Investing in share-based assets has proved to be the best way for providing growth that outstrips inflation. There is a risk attached but, when you invest over the long-term, there is more time to recover your losses after a fall in the stock market.

Different types of risk

Capital risk

Capital risk will apply to all of your investments

Technically speaking, every investment carries at least some risk that you won't get back all the capital you invested. This is known as capital risk. However in practice some products are so safe that it's virtually certain you'll get what you were promised. For example, An Post savings accounts and Irish government bonds are backed by the Irish government.

Inflation risk

Inflation risk is the threat of rising prices eroding the buying power of your money. This risk is greatest if you invest in savings accounts or government bonds. 

Many savings accounts don't pay interest equal to the rate of inflation after tax, so even if you don't spend any of the interest, the 'real' value of your savings falls. If you spend the interest, the problem is even greater.

Shortfall risk

Shortfall risk means failing to reach your investment goal because the return on your investments is too low. For example, say you want to save €20,000 within 20 years and can get a return of 3.4% after tax from a savings account. This means you'd have to save €140 a month to reach your target. If you can only save €100 a month, you'd need a return of 9.5%.

To reduce shortfall risk, you need to invest at least some of your money for a higher return but this may involve taking some capital risk.

Share-based risks

Share-based risks are a bit more complex

Specific risk

This is the risk that the company you've invested in performs badly. Some companies will fluctuate more than others. Cautious and first-time investors should be especially concerned to keep this type of risk to a minimum.

You can reduce your specific risk by investing across a diversified basket of shares. This way, if one of them goes bust, or falls heavily, the overall effect on your portfolio is less.

The best and cheapest way to spread your risk is to invest in pooled investments like unit trusts or investment trust. They are called pooled investments because you pool your money with other investors to buy a wide range of shares.

Market risk

This is the risk of a fall in the particular asset class where your money is invested. When an asset class such as equities falls you will usually find that most shares are dragged down with it. Some fall by more than the average, some by less, but few will buck the overall trend.

A good way of avoiding market risk is to invest your money gradually, for example through a monthly investment scheme as this will smooth out big variations in the price.
You can also reduce market risk by investing in a range of asset classes such as deposits, bonds, property and shares. This works because not all asset classes will rise and fall together by the same amount, so if one falls, you should be able to limit your losses because the others won't have fallen as much.

Currency risk

If your money is invested in stock markets outside of the eurozone, then you will face currency risk. Wherever your money is invested, it will have to be converted into euro when you want it back. As a result, movements in the exchange rate will affect the value of your investment - this can work both in your favour and against you.

You can limit currency risk by diversifying, for example through an international fund that spreads its investments around the globe. Alternatively, you can avoid currency risk by sticking to the eurozone, but this increases your market risk.