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Do Your Investments Have Political Risk Factors?

Gelman, Rosenberg & Freedman CPAs is a member of CPAmerica International, an association of CPA and consulting firms that provides industry knowledge including insightful articles, to help member firms serve clients and other individuals and organizations.

Risk is not necessarily a bad thing.

Every  investment has risk. A common definition of risk is deviation from an expected  outcome. That deviation can be positive or negative.

To achieve higher returns in the long term, investors generally must accept  greater volatility in the short term. The amount of volatility an investor is  willing to accept is often referred to as “risk tolerance.” Your capacity to  accept volatility is based on your specific financial circumstances, while  taking into account your psychological comfort with uncertainty and the  possibility of incurring short-term losses.

globeInvestors  must consider many types of risk, including credit risk, market risk, liquidity  risk and political risk:
  • Credit risk is the risk of borrowers defaulting on  their loan obligations.
  • Market risk is the risk that the value of a  portfolio will decrease due to market conditions.
  • Liquidity risk is the risk that a given asset  cannot be traded quickly enough in a market to prevent loss or make a profit.

Political  Risk

Most investors associate the term  “political risk” with stocks and bonds issued by non-U.S. corporations and debt  issued by foreign governments. However, the U.S. portion of your portfolio may be  every bit as susceptible to political risk as the international portion.

Political risk refers to complications  businesses and governments may face because of what are commonly referred to as  political  decisions. Generally speaking, political risk is a risk that your investment objectives will not be achieved as a result of such nonmarket factors as changes in macroeconomic and social policies, as well as political  instability.

While many U.S. investors normally  associate political upheavals such as coups, civil wars and insurrection with third-world countries, and they may associate  expropriations and currency devaluations with unstable economies, they don’t  have to go beyond the borders of the United States to find evidence of  political risk. This country has certainly seen its share of shifts in  macroeconomic policies – think last summer’s debt ceiling debate; social  policies – think the healthcare debate; and political stability – think the 2000 presidential election.

Here is a rundown of some  political risk factors in the United States that investors should consider:

High unemployment –  As President Obama, congressional leaders and Republican presidential  candidates present dueling prescriptions to stimulate jobs growth, the risk of  stagnation until after the 2012 presidential election looms large. The Federal Reserve has injected $2.3 trillion into the economy since late 2008 and has  slashed interest rates to near zero. Will Chairman Bernanke act again in an  effort to stimulate a sputtering economy by easing monetary policy?

Political rancor over debt  and deficits – Will Democrats and Republicans find common ground for the $1.2 trillion budget gap that must be closed as a result of last summer’s debt  ceiling compromise? To accomplish anything close to this goal, it appears that  Democrats may have to renegotiate favored social programs, and Republicans may  have to concede to tax increases.

Political gridlock –  Can a Democratic White House and Senate find common ground with a Republican  House of Representatives to move any significant legislation forward prior to the 2012 election?

Campaign 2012 – The president,  one-third of the Senate and the entire House of Representatives are running for election in November 2012. What is best for re-election is more likely to affect the political compromises that are made – or not made – between now and  next November, not what is best for the economy.  Meanwhile, the Republican presidential contenders will jockey first for their party’s nomination and then  for the presidential election. During the campaign, the Republican nominee and  President bama will propose programs and make promises that they may or may  not be able to pass or keep after the election.

China – How does China  affect investment in the United States? China holds over $2 trillion of dollar-denominated assets, including U.S. Treasury bonds that were owngraded  by Standard and Poor’s. Were China to significantly realign ts investment  portfolio, other holders of U.S. government bonds would certainly feel the hockwaves.

Portfolio  Diversification

Experts say the best way to manage risk  in your investment ortfolio is through diversification. Most recommend some  portion of your investments be in markets outside the United States.

Many investors view international  investing as taking on an ncreased amount of political risk. Savvy investors  understand that there is plenty of political risk right here at home.


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