A different way of viewing your investment risks through the layer of three lenses
Sanjib Saha
25 July 2026
What is risk?
From a philosophical perspective, it’s the possibility that one or more future objectives will remain unmet.
Along those lines, investment risk is the possibility of missing one or more of our future objectives due to insufficient fund.
I find this to be a simple yet powerful definition of investment risk. Here’s why.
We set aside money for various future financial objectives – getting a car next year, buying a house in 5 years, sending a kid to college in 10 years, having a worry-free retired life in 20 years, and so on. We invest our savings so that it grows over time and helps make these financial goals a reality. Anything that financially jeopardizes those goals is an investment risk.
Can we reduce our investment risks to improve the odds of achieving our financial objectives? Absolutely, if we understand and manage different types of investment risk.
To be sure, we also don’t want to go too far in the pursuit of reducing risk. Risk and return are tightly related. Avoiding one usually means avoiding the other. A low rate of return may force us to either scale down our financial objectives. Conversely, chasing astronomical returns can expose us to very high risk of failing to meet those same financial objectives.
Let’s look at the three main types of risk.
Default risk: This is the risk that an investment permanently loses value, either partially or completely. This happens when the investment “defaults” on the explicit or implicit promise of a positive return – borrowers unable to repay debt, business going bankrupt, and so on.
Unexpected Inflation risk: This is the risk that the cost of a financial objective turns out to be much higher than what planned for.
Here’s a simple example.
John is diligently saving money for buying a home in 5 years. His calculation assumes home prices will rise by up to 4% annually. Fast forward five years, and home prices have instead risen by 10% per year. Suddenly, the funds John earmarked for the house are no longer enough for buying the home he had hoped for.
That’s unexpected inflation risk, because the actual inflation was far higher than what he had planned for.
Liquidity risk: In simple terms, it’s the possibility that when we need the money, we won’t be able to sell our investments at a fair price. We are either stuck with it or forced to sell at a big loss.
Some investments are inherently illiquid. Real estate is one such example, thanks to high commissions, long transaction timeline and potentially a large tax bill. The sooner we need the money, the lower our net proceeds are likely to be.
Conversely, certain investments are highly liquid by nature because they’re in constant high demand. Still, it doesn’t guarantee a fair price if the investment itself is highly volatile.
There are many other investment risks, but for most investors, managing these three risks – default risk, unexpected inflation risk and liquidity risk – goes a long way.
Can we eliminate investment risks altogether? US Treasury investments – debt issued and backed by the US Government – come closest to being near-zero risk, especially over short time periods. That’s why short-term Treasury Bills are often considered as “risk-free investments” for benchmarking and statical analysis.
Long-term, however, is a different story.
Strictly speaking, there’s hardly any “truly risk-free” investment over long periods. No matter how airtight an investment appears, there will always be some unavoidable risk always remains – however small. And no, keeping money under the mattress is not risk-free either.
Perhaps the better question to ask is: should we try to eliminate risk altogether? For most people, the answer should be YES for short-term financial goals and NO for the long-term ones.
High risk means higher uncertainty in achieving our financial goals. So, if a financial objective is imminent and we are close, we don’t generally want to jeopardize it by keeping the fund in a volatile investment. On the other hand, stable investments also tend to offer low returns, which makes them unsuitable for the long-term financial goals.
How do I approach these risks for my own investments
My own investment strategy is intentionally simple, and undoubtedly boring. I avoid most unnecessary sources of risks. My approach won’t produce the highest possible long-term return, but it helps me sleep well at night and saves my time and energy for other things.
To reduce default risk, I start by splitting my investments between bonds (lower return but higher certainty for short and midterm goals), and stocks (less certainty in the short term but better long-term return potential).
For bonds, I don’t compromise on the credit quality of the issuer. For stocks, I diversify broadly using low-cost passive index funds covering both US and International markets.
My hedge against unexpected inflation risk is two-prong. For the stable portion of my investments, I prefer Treasury Inflation Protected Securities (TIPS). I mostly avoid fixed income investments that aren’t tied to inflation.
The growth-oriented part of my portfolio is almost exclusively invested in stocks, which historically has done a good job in keeping up with unexpected inflation over long periods.
To manage liquidity risk, I keep things straightforward. For starters, I intentionally avoid “inherently illiquid” investments such as private credit and equity, annuities, exotic investments or even real estate.
My stock investments are held in broad market-cap weighted ETFs with high liquidity. In addition, I’ve built a ladder of individual TIPS bonds maturing in different years, along with short/mid-term Bond ETFs. This way I can weather prolonged stock market downturns without having to sell stocks at unfavorable prices.
My investments are undoubtedly boring and unexciting. In return, I spend little time worrying about my ability to meet my financial objectives.