Risks

Introduction:

As of every investment, not excluding stocks, there is always a factor of risk that has to be taken. A risk is something that causes one to be at a disadvantage in an investment.

Below are the different types of risks involved when investing in stocks.

1) Business Risk: The Company in whose stock you invest may not generate the sales and earnings growth as expected. Moreover, the management of the company may not be able to bring the company to the next stage of development. As a result, the price of the stock may remain low or even fall.

Remedy: Study the background of the company of the stock you wish to invest in. Make a sound judgment for yourself

2) Stock-specific risk: This risk is also known as unsystematic risk. This is the risk associated with using all your capital or money to invest in only 1 stock or company. If the particular stock you placed all your bet on drops drastically, trouble will be spelt for you as a lot of money will be lost.

Remedy: As the old adage says: “Do not put all your eggs in 1 basket.” Diversification is the key to lighten the impact of such a risk or totally eliminate this risk. By investing in a broad range of stocks from different industries, theoretically, if one of your stock prices fall, others might rise to offset your losses.

3) Liquidity or marketability risk: This risk refers to the scenario when you try to sell off your stocks but realize that it is too difficult to do. This happens when there are too few investors in that market.

4) Interest rate risk: This happens when the market price of the stock or security fluctuates inversely to changes in interest rates. When interest rates fall, the prices of your particular stock or security will rise. Conversely, when interest rates rise, the prices of your particular stock or security will fall. This is due to the forces of supply and demand. When interest rates are low, most people will invest in stocks or similar securities as they have better returns. However, when interest rates are high, people might want to invest in a less risky investment yet have almost equal returns.

5) Systematic risk: This risk is also known as the market risk. This risk is associated with the movement of the overall market. When the entire market declines, it is most likely that your portfolio of shares will also decline in value resulting in you making a loss.
Note: Diversification will not protect you from this risk.

6) Inflationary or purchasing power risk: This risk, as hinted by its name is the risk associated with inflation. As inflation erodes the purchasing or spending power of money, hence, your money is worth less then it should be.

7) Political risk: This risk is high when stocks are associated in places or countries where the political situation is unstable. Instability can severely reduce productivity of the company whose stock you own. At worst, the country could decide to nationalize all businesses, in which this case all your investment in the company will be lost.
Remedy: Invest in companies whose base countries have a good line of reputation for political stability.

8) Taxation risk: Tax is charges imposed by the government of a country on one’s earnings or profits. Changes in tax rates could prove distasteful if much of your earnings from cash dividends or capital gains are heavily taxed.