We’ve said it before, and we’ve said it often: There is no such thing as risk-free investing. Certainly, there are varying degrees of risk when investing. But all investments carry risks including (but not limited to) capital, default, currency, inflation, and interest rate risks.
Then there is macroeconomic risk. Sometimes known as “macro” risk, this risk type considers the broader national (and, in some cases, international) economy when it comes to capital asset investments.
Economics 101: Macroeconomics
First, it’s a good idea to understand the meaning of economics. In its most basic form, economics involves the creation and consumption of goods and services. It also involves the transfer of wealth.
Digging deeper, the study of economics involves:
- Microeconomics, which focuses on the decisions and resource allocation among individuals, households, and firms
- Macroeconomics, which studies large-scale, country- and global-wide economic factors and their impact
Macroeconomic metrics include:
- Gross Domestic Product: A country’s overall output of goods and services
- Unemployment: How many people from an available labor pool can find work
- Inflation: An increase in the price of goods and services along with the decline of purchasing power over time
Explaining Macroeconomic Risk
Given that macroeconomics involves national economic factors, macroeconomic risk describes the impact of those factors on investments. Specifically, national and international economic booms and busts can lead to a change in an asset’s value and/or return on investment.
From a corporate point of view, for example, an economic slowdown could mean reduced demand, resulting in lower profit margins and earnings growth. If you own stock in this company, you might see a reduction in your dividend income and/or a depreciation in the stock’s value.
Bonds can also be impacted by macroeconomic risk. Because bonds deliver a specific return on investment (also known as yield), inflationary increases can decrease the value of that return, over time.
Potential Risk-Reduction Strategies
It’s difficult to avoid macroeconomic risks. But you can potentially reduce the impact of this risk type on your portfolio. One way is with modern portfolio theory, which supports investment diversification. Real estate, hedge funds, and other alternative assets can also be helpful during an economic downturn. Absolute return investments—mutual funds that earn a positive return over time—could also help support portfolio diversification.
Portfolio Strategy and Macroeconomic Risk
When performing due diligence on investments, it’s important to example issues like yield and returns. Just as important is risk analysis, especially that of macroeconomic risk. The better you understand how economic factors might impact asset performance, the more likely you are to reach your specific investment goals.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
All investments have an inherent level of risk. The value of your investment will fluctuate with the value of the underlying investments. You could receive back less than you initially invested and there is no guarantee that you will receive any income.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
Hypothetical examples shown are for illustrative purposes only.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
