Capital Risk
The most basic investment risk is the simplest to understand: you might lose your money.
What Is Capital Risk?
- Capital risk (also called principal risk) is the risk of losing part or all of your original investment
- Applies to virtually all investments: stocks, bonds, mutual funds, ETFs, and more
- The degree of capital risk varies widely by investment type
Think of it this way: When you invest, your money is no longer guaranteed. Unlike a savings account with FDIC coverage, most investments can decline in value, and there is no promise you will get back what you put in.
Which Investments Are Affected?
| Investment | Capital Risk Level | Why |
|---|---|---|
| FDIC-insured bank deposits (up to $250,000) | None | Government guarantee |
| U.S. Treasury securities | None (if held to maturity) | Full faith and credit of U.S. government |
| Investment-grade bonds | Low to moderate | Could default, though unlikely |
| Equities (stocks) | Moderate to high | Stock price can fall to zero |
| Options | Very high | Can expire worthless (100% loss of premium) |
- Equity investments have higher capital risk than high-quality bonds because stock prices are more volatile and there is no guaranteed return of principal
- FDIC insurance protects bank deposits up to $250,000 per depositor, per institution (one of the few true capital risk protections available)
Exam Tip: Gotchas
- U.S. Treasuries are free of capital risk only if held to maturity. If you sell a Treasury bond before maturity when interest rates have risen, you could receive less than you paid (interest rate risk). The exam tests whether you understand this distinction.
Reducing Capital Risk
- Diversification spreads capital across multiple investments so a loss in one does not wipe out the entire portfolio
- Asset allocation balances higher-risk and lower-risk holdings based on an investor's time horizon and risk tolerance
- No strategy eliminates capital risk entirely (except FDIC-insured deposits within the coverage limit)
Capital risk is about losing your principal. Next, we'll look at a related but distinct risk: the possibility that a bond issuer simply refuses to pay you back.