Compared to investing in cash or bonds, investment in stocks is associated with a higher level of risk. However, there is also the possibility that equity investments may provide larger returns. If you can better understand the risks associated with your investments, you will be able to make more informed choices.
When considering an investment in shares, here are seven potential dangers that you should be aware of.
Volatility
Investors often confront unanticipated highs and lows due to the unpredictable nature of stock markets. The volatility of a stock price, which refers to its tendency to vary fast and by a substantial amount, may majorly influence a portfolio. When you own just one firm or sector, you expose yourself to a higher level of risk than when you diversify your holdings.
Concentration
When you invest in a limited number of stocks, your whole portfolio is susceptible to losing if anything goes incorrect with just one of the firms you have invested in. It is more likely that a single firm would sustain losses than that the market will experience a complete meltdown.
Increasing your diversity by purchasing a variety of different stocks may help lessen the risks that are connected to investing in specific firms. One way to execute this goal is to invest in businesses of varying sizes across various geographies, markets, and industries.
Liquidity
The ease with which capital may be bought and sold is its liquidity. It may be difficult for you to sell the stock you possess if there are not enough people interested in purchasing it. Stocks that have a low trading volume might be more difficult to sell, which presents a risk since there is a possibility that you will be unable to sell an investment at the optimal moment for you.
Foreign-exchange risk
The risk of foreign money rate fluctuations is borne by Canadian investors interested in other countries. A shift in the currency exchange rate might impact the performance returns of an investment if you purchase or sell stocks denominated in a foreign currency.
A weakening of the Canadian currency may increase the returns on abroad investments. In contrast, an appreciation of the Canadian dollar may reduce the profits on investments made abroad, notably in the United States. Is that accurate? Your perspective on the long term is important here. According to the findings of several studies, fluctuations in the rates of exchange for foreign currencies have a generally lesser influence on performance returns over the long run than they do over the short term.
Geopolitical risk
Stock prices can be influenced by the political stability and financial strength of nations located all over the globe. Both established and developing markets are susceptible to market volatility caused by factors such as politics, newly enacted laws, financial regulations, tax policies, and trade conflicts. The problems might affect the nation in which the company’s headquarters are located or the nations in which it does business.
Margin
When you buy stocks on margin via RBC Direct Investing, you borrow money from the brokerage and put up your assets as collateral for the loan. The usage of margin tends to amplify the volatility of a portfolio and may generate additional risk related to interest rates. For instance, a rise in interest rates will increase the cost of borrowing money, which will make it more difficult to generate positive returns on investments.
Interest-Rate Risk
There are several different ways rising interest rates might act as a headwind for equity markets. For firms, this might result in greater expenses associated with borrowing money. Because of this, their return on capital can be affected.
Business Risk
This refers to the possibility that the firm you have invested in may go out of business. If this occurs, you risk losing part or all of the money you have invested. Because they do not have as long of a track record for investors to analyze, investors often see younger firms with a higher level of risk than more established companies.
Liquidity Risk
To realize profits from an investment, an investor has to locate a buyer interested in purchasing the investment from them at their current price. If the investor cannot locate a buyer, the value of the investment will remain entombed inside it. It is generally accepted that some assets, such as stocks and bonds, are more liquid than other types of investments (like real estate). If you require to access the value of your investment but cannot find a buyer, you run the danger of being compelled to reduce the price you are selling the asset to attract a purchaser.
The Danger of Inflation
Even the “safest” investments have their own unique set of potential downsides. For instance, if you hazard in a savings account, you won’t lose any of the capital (or money) that you put in; you will probably end up with more money as your funds accumulate interest. This is because you won’t lose any of the money that you put in. However, if the rate of inflation, also known as the increase in prices, is higher than the interest rate that your savings yield, you may discover that you have less purchasing power than you had when you first started saving.
