Investing can be a great way to grow your wealth and secure your financial future, but it’s not without its risks. In fact, the risks of investing are real and can be daunting, especially for those who are new to the market or unsure of how to manage their investments. It’s important to understand that every investment comes with risk, whether it’s the risk of losing your principal investment, the risk of market volatility, or the risk of inflation. However, that doesn’t mean you should avoid investing altogether. With the right knowledge and strategies, you can manage these risks and potentially earn significant returns on your investments. At NPW, we understand the importance of managing risk in investing, which is why we’ve created this guide to help you understand the real risks of investing and what you can do to mitigate them. Whether you’re a seasoned investor or just getting started, this guide will provide you with valuable insights and strategies to help you make informed investment decisions.
Investors know that markets and economies are volatile and there is no such thing as a sure thing when it comes to investments. Every investment has some investment risk. But what is investment risk? Here we look at the four major types of risk involved in investment and find out how you can minimize the risk from your investments.
Understanding the Different Types of Investment Risks
When it comes to investing, there are several types of risks you need to be aware of. Market risk is the most common, which is the risk that the value of your investment will decline due to factors such as economic conditions, geopolitical events, or industry changes. Other types of risk include credit risk (the risk that a borrower will default), liquidity risk (the risk that you won’t be able to sell your investment), and inflation risk (the risk that the purchasing power of your investment will be eroded over time). By understanding these different types of risk, you can better assess the risks associated with different investment opportunities.
Company Risk
When companies experience a high degree of business risk, they could impair their ability to provide investors and stakeholders with acceptable returns. Bad management is an example of this risk; if a CEO makes poor decisions, causing the business to incur losses or even to fail, it will trickle down to lower dividends on stocks for every investor. Although company risk cannot be entirely avoided or even accurately predicted – it is the nature of capitalism – a good analyst or wealth advisor can manage investments to escape its effects.
Strategic risk is one of the four major types of company risk and happens when a business does not operate according to its business plan. Its strategy then becomes less effective; it will likely battle to reach its goals.
Compliance risk is the second form of business risk. This occurs in industries and sectors which are highly regulated, such as industries associated with finance, pharmaceutical drugs or alcohol. compliance risk occurs when the company does not comply with the legal requirements of the country or region in which it operates.
Operational risks arise internally when day-to-day operations of the company break down. This can be as simple as a fire destroying a major manufacturing plant or far more complex in nature.
Reputational risk can result in the company losing customers and brand reputation. Companies that have been found guilty of systemic racism, for example, have lost money on the stock market, leading to losses for individual investors.
Company risk can be significantly reduced by doing research. Analyze the company’s quarterly earnings results, listen to management commentary on those results, read finance articles in reputable publications and measure performance. This information has to be made publicly available for all listed companies.
Common Mistakes Investors Make and How to Avoid Them
Investing can be complex and intimidating, which is why many investors make mistakes that can negatively impact their portfolio. One common mistake is failing to diversify your portfolio, which can increase your overall risk. Another mistake is trying to time the market, which is difficult to do successfully and can result in missed opportunities. Other mistakes include investing based on emotions, rather than on sound analysis, and failing to monitor your investments regularly. To avoid these mistakes, it’s important to develop a solid investment strategy and stick to it.
Volatility And Market Risk
Stock prices are determined by the two main determiners of anything in business: supply and demand. Demand for anything can change with little to no warning and your stock could take a massive tumble. However, the smart investor can minimize exposure to these effects.
Stock prices will fall when capital is pulled out of the stock market and market crashes can happen. These setbacks are likely to be temporary but you must be prepared for some setbacks in this business.
Because of the temporary nature of the downturns, it is generally best to avoid selling when the stock is down so that you can hold on and reap the rewards when the market returns to growth. As the old saying goes, “don’t put all your eggs in one basket”; rather keep some liquidity to cover expenses and possibly take advantage of other opportunities.
Portfolios can be designed to limit exposure to market volatility. Stocks tend to have a higher risk than bonds or cash. Consider defensive investments like all-weather portfolios or other ways of diversifying.
The Importance of Diversification in Managing Investment Risk
Diversification is a crucial component of any successful investment strategy. By spreading your investments across different asset classes, industries, and geographies, you can reduce your overall risk and increase the likelihood of positive returns. Diversification can also help protect your portfolio from market fluctuations and unexpected events, such as a recession or a geopolitical crisis. However, it’s important to note that diversification does not eliminate risk entirely, and you should still conduct careful research and analysis before making any investment decisions.
Opportunity Cost
This can be understood as the risk of missing out. You do not want to be left behind while other investors are bragging about their returns and you are left saying “Should have, would have, could have”. While you do not want to risk everything, you do need to take some chances to achieve growth.
Liquidity Risk
Liquidity is simply how quickly and easily an investment can be exchanged for cash. Stocks and bonds are relatively liquid while real estate is one of the least liquid investments available. This is not to say that all your assets should be liquid, but that it is advisable to have some level of liquidity in your investment portfolio in case of an emergency.
Being Proactive When Dealing With The Risks of Investing
All of these are real risks that investors may face. Ask an investment advisor which is the greatest risk when investing in stocks and make sure you know what you are investing in to minimize the risks of investing.
Ensure you have the best financial future by partnering with a team that shares your values, thoroughly understands your goals, and has a keen desire to earn your trust and confidence. Nour Private Wealth (NPW) is a Canadian company with a team of wealth advisors servicing clients across seven provinces. Let us manage your portfolio using a diverse asset classes, delivering strong returns while minimizing investment risk. Contact us today and speak to one of our wealth advisors.
By taking a proactive approach to manage your investments and staying vigilant for potential risks, you can make informed decisions that will help you achieve your financial goals over the long term. Ultimately, it’s up to each individual investor to decide how much risk they are comfortable taking on, but by understanding the risks of investing and taking steps to mitigate them, you can increase your chances of success.
