Quick Answer
Capital risk, also called principal risk, is the chance of losing part or all of an original investment. It ranges from none for FDIC-insured bank deposits and Treasury securities held to maturity, to low for bonds, moderate to high for stocks, and very high for options. Diversification and asset allocation reduce, but never eliminate, 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.
What Should You Check on Exam Day?
- Can you explain why Treasury securities carry no capital risk only if held to maturity?
- Do you know why equities carry higher capital risk than investment-grade bonds?
- Can you state the FDIC insurance limit that protects bank deposits from capital risk?
- Do you know two strategies that reduce, but never eliminate, capital risk?