Many people think of investing as an inherently risky endeavor, but in practice the key is not to avoid risk altogether — it is to understand and manage it. When you invest in financial instruments, there is always the potential for gain as well as value fluctuations, and that uncertainty is an inseparable part of investing.

For some people, investing seems too complex or even intimidating because of the fear of losing hard-earned savings. Yet financial markets are not a game of chance — they operate according to identifiable patterns, and understanding those patterns makes it possible to make more thoughtful and rational decisions.

In this article, Kristiāns Purviņš, Head of the Investment Platform Department, explains what investment risk is, how it arises, and how to reduce it in practice.

What is investment risk, really?

In the financial world, risk does not usually mean the complete loss of a capital investment. Simply put, investment risk is the possibility that the outcome will be worse than expected. It can manifest in several ways, for example:

• The value of your investment may decline,

• Returns may be lower than planned,

• Your capital may be locked up for longer than you anticipated.

That is why, in investing, what matters is not just return on investment, but the relationship between return and risk.

Types of investments and their risk levels

Financial markets operate on a fairly straightforward principle: higher potential returns almost always mean higher risk.

Different types of investments differ in both their risk level and potential return. For example:

• A savings account typically carries very low risk and correspondingly low returns,

• Government bonds offer low risk and low to moderate returns,

• Corporate bonds carry moderate risk and moderate returns,

• Stocks (equities) are generally associated with moderate to high risk and potentially higher returns,

• Start-ups and venture investments involve very high risk but also very high potential returns.

It is important to understand that a riskier investment does not automatically deliver higher profits. It simply means that the potential gain is greater — but so are the potential losses.

An additional factor to keep in mind is inflation, which affects even seemingly safe investments. For example, if you have invested in government bonds with a 2% yield but inflation is running at 5% in the same period, your real purchasing power has effectively decreased.

In summary — an investor's goal is not to eliminate risk entirely, which is impossible, but to find a risk level that suits their individual circumstances.

Diversification — one of the most important risk-reduction principles

If one approach to risk management in investing had to be singled out, it would be diversification — the practice of spreading investments across different assets. This can include both traditional assets and alternative financial instruments such as asset-backed securities (ABS), which are also available on the TWINO platform, where investors put their capital into securities backed by loan portfolios.

A diversification strategy can be implemented in several ways, by investing across:

• Different asset classes (equities, bonds, and alternative investments such as asset-backed securities),

• Different geographic regions,

• Different industries and sectors,

• Different risk levels.

Market volatility and long-term trends

Historical data from global financial markets (compiled and analyzed over nearly 100 years) reveals certain consistent trends:

• In the short term, markets can be highly volatile — declines of 20–50% have occurred multiple times throughout history,

• Over the long term, however, despite crises, wars, recessions, and other setbacks, equity markets have experienced consistent long-term growth.

The S&P 500 is one of the most important stock market indexes in the world. It tracks the share price performance of the 500 largest publicly listed companies in the United States, providing a broad picture of overall market conditions, and serves as one of the primary benchmarks for global financial markets. The index represents companies from various sectors — technology, healthcare, financials, consumer goods, and others — making it one of the best indicators of the economic health of large corporations.

Over this period, equity markets have experienced several major crises, including:

• The Great Depression of the 1930s,

• The oil crises of the 1970s,

• The dot-com bubble collapse in 2000,

• The global financial crisis of 2008,

• The COVID-19 crisis of 2020.

Yet as historical data shows, after each crisis markets have recovered over time and reached new record highs.

This is one of the primary reasons why a long-term approach is fundamental to investment success. When investments are made with a 10–20 year horizon, short-term volatility becomes far less significant.

How should investors respond during market volatility?

The greatest challenge for investors is usually not a lack of information, but emotions. When markets fall, there is an urge to sell and "cut losses," while during rapid growth the fear of missing out takes over. Yet historical experience shows that the most consistently successful approach is disciplined and consistent action, rather than attempts to time market peaks and troughs.

When markets fall

Market downturns are a regular occurrence. During such periods, investors typically have three rational options:

• Hold investments and do nothing. If a portfolio is diversified and the investment horizon is long-term, panic-driven selling often means realizing losses at precisely the worst possible moment.

• Continue investing regularly. If an investor contributes periodically (for example, monthly), a market downturn actually represents an opportunity to buy assets at a lower price (dollar-cost averaging).

• Review the portfolio, but not impulsively. Downturns sometimes reveal excessive risk or insufficient diversification, which may warrant reconsidering the portfolio structure.

The most important principle here is simple: market downturns are unpleasant, but they are also a normal part of the investment cycle.

When markets rise rapidly

During rapid growth, investors often face the opposite risk — excessive optimism. When prices climb, it can feel as though the market will rise indefinitely, and investors may begin taking on more risk than they originally intended.

In such moments, a rational approach might include:

• Maintaining your original investment strategy. If the goal is long-term wealth accumulation, there is no need to change the plan simply because markets have risen.

• Periodically rebalancing your portfolio. If the value of equities in the portfolio has grown significantly, it may be prudent to sell a small portion and restore the original asset allocation.

• Avoiding FOMO (fear of missing out). In history, nearly every rapid surge has eventually been followed by a correction.

The key takeaway: both during market downturns and periods of growth, the most successful investors are those who follow a clear long-term strategy. This typically means a diversified portfolio, regular investing, and emotional discipline.

How to reduce investment risk — 5 practical tips

To better understand how investment risk management works in practice, here are some fundamental principles.

1. Only invest money you will not need in the near term

Market volatility is inevitable and not always predictable, so it is important not to over-commit and invest money that you may need:

• For expenses in the coming months,

• For unexpected emergencies,

• For loan repayments.

Financial advisors recommend first building an "untouchable" emergency fund (typically covering 3–6 months of living expenses).

2. Diversify your portfolio

As mentioned above, one of the primary tools for risk reduction is diversification.

In practice, this might mean:

• Investing in multiple securities,

• Spreading capital across different financial instruments,

• Spreading capital across multiple instruments, issuers, or platforms.

This helps avoid a situation where a single poor investment undermines your entire portfolio.

3. Think long-term

In the short term, markets can be highly volatile, but over longer periods fluctuations tend to smooth out. A strategy that has delivered stability and long-term success for thousands of successful investors involves:

• Investing regularly, without trying to "time the market" for the perfect moment,

• Focusing on long-term outcomes,

• Keeping a level head during crises and avoiding emotional decision-making.

4. Evaluate risks before investing

An investor ready to take their first steps into the world of investing will naturally ask: what should I check before investing?

• Understand and clarify how returns are generated.

• Identify the investment model and which risk category it belongs to.

• Determine the investment term and whether — and under what conditions — it is possible to withdraw funds early if needed.

• Understand what collateral or other protection mechanisms are in place.

• Identify the main risks associated with the chosen sector or asset class.

5. Be wary of "Too good to be true" offers

Just as in many other areas of life, it pays to listen to your instincts when it comes to finance. If something sounds too good to be true, there is a strong chance that you are not being told the whole story.

Be particularly cautious about:

• Guaranteed very high returns,

• Non-transparent investment models,

• Projects without clear, accessible information.

Before investing, it is always worth asking one simple question: where exactly does the profit come from?

Investment risk: Final thoughts

Investment risk is an inseparable part of financial markets — but it is not a reason to avoid investing altogether.

Quite the opposite: by understanding risk and applying principles such as diversification, long-term thinking, and consistency, investors can significantly reduce their exposure to investment risk.

Investing is not a sprint, but a long-term process. Investors who understand risk and take a thoughtful approach are generally better equipped to make consistent decisions even in volatile market conditions.

Email: [email protected]

Address: Dzirnavu iela 42, Riga, LV-1010, Latvia

This material is informational and is not an individual investment recommendation.