A Guide To The Risks Involved In Investing In Stocks

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You need to know these risks when investing in stocks: investing in stocks could result in the loss of all the money invested and in some instances even more. Prior to investing in stocks it is important to acknowledge and accept the risks inherent in such an undertaking.

Important Points on Risk

There is no guarantee of returns:

Even though the performance of stocks over the long term has been exceptional, making substantial money at a certain point in time or a given stock is not guaranteed. While you can assess a stock using several indicators, it is impossible to predict future performance of a stock. Whether the company will remain a going concern, pay dividends, or whether its price will go up is never guaranteed.

There is a possibility of you losing your money: Prices of stocks will be affected by a myriad of variables. A level of comfort with risk and accepting that you selling or buying stocks might result in

Prices of stocks will be affected by a myriad of variables. A level of comfort with risk and accepting that you selling or buying stocks might result in significant financial loss is required particularly if you are a short-term investor. If you are an investor using leverage either by short selling or buying on margin it is possible to lose much more than your investment sum. You need to know these risks when investing in stocks if you are planning on using margin.

Market Volatility

The stock market operates with unpredictable up and down movements.Volatile stocks will usually change in price a lot more quickly which could make you lose a lot of money if the price of the stock were to fall on short notice.

Looking at a stock’s volatility every day may not be enough. Largest quarterly and monthly losses of the stock may be a better measure of a stock’s volatility. Volatility may be determined through several measurements:

Standard Deviation – measures the divergence between the high and low of the stock from the average. Greater variation means that the stock has a history of higher volatility.

Beta – Measures the performance of a stock in comparison to a given standard such as the S&P Composite Index. A score of 1.0 is an indication that the stock is in tandem with the stock markets up and down movements. Betas between 0.0 and 1.0 indicate lesser divergence. A beta larger than 1.0 indicates greater price divergence. A negative beta score is an indication that the stock is moving in an opposite direction to the index.

5 Tips on Risk Management

I. Diversify your Portfolio

You could reduce your exposure to volatility in your stock by investing in stocks of companies that have different fundamentals such as:

  • Different Industry – companies in different industries will usually have different circumstances. For instance, while tech stocks may be falling, energy stocks may be surging.
  • Stock Type – Buy preferred shares as well as common shares to lower your risk. While they offer a lower return than common stocks, they pay a fixed dividend and offer lower risks. Click here for the difference between {preferred and common stock.
  • Company Size – While investment in a new and small company offers greater potential for growth and profit, a large company offers a better track record, stability and less risk due to its long history. Spread your risk by having stock in both types of companies.

Prior to making a decision on purchasing a portfolio of stocks or even one stock, you should try to align it with your overall financial goals, your risk tolerance, and how it is aligned with your overall portfolio. Learning more about the importance of diversification and the risks of investing will be invaluable in reducing your risk.

II. Be A Long-Term Investor

The stock market is very volatile in the short term but will perform well over the long term. Do not buy stocks with money you may need in the short term as you may have to sell when volatility has pushed prices down. You will lose money since you bought high and are selling low.

III. Timing the Market is Futile

Trying to time the market is a bad idea. While prices may rise fast as more investor buy to catch the rise in stock prices, the prices can fall just as fast when they start to sell to take their profit out of the market. While some investors will sell as soon as the price plunges, this is not advisable as you will lose money. You need to know these risks when investing in stocks. If you do not sell you do not lose and may even make money as the price may go back up over the long term. Always take the approach of ignoring short-term fluctuations as stocks are long term investments.

IV. Get an Adviser if you are Just Starting Out

Your risk is amplified if you invest without knowing the workings of the stock markets, bear and bull runs, or how to develop an investment strategy. It is critical to find an expert adviser who will advise you on how to pick stocks and investments that are aligned with your objectives and levels of tolerance for risk.

V. Buy Private Stock with Caution

Some companies offer their stock privately rather than listing it on the public stock exchange. Private stock is usually tricky to sell since before shares change hands, other shareholders have to approve the sale and the sale price. You need to know these risks when investing in stocks:

  • You may be scammed
  • It may call for a huge investment
  • You may be prevented from selling the stock as you wish

Investing Offshore may be Risky

Canada’s banking and security laws protect investors who feel aggrieved in their investments by offering recourse in the courts. Investment outside the country does not have that protection. Be very careful investing offshore as such investments may be scams. You need to know these risks when investing in stocks outside the country so that you make an educated decision.

Sourced from: GetSmarterAboutMoney

Image source: Thinkstock/PhonlamaiPhoto

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