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Stock Investment Risk

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What are the Risks of Investing in Stocks?

Investing in the stock market is inherently risky. There is a very real risk that you will lose some or all of your initial investment. If you speculate with leveraged accounts (buying stocks on margin) you can risk far more than your initial investment. If you diversify your portfolio, pick your stocks carefully and do a proper valuation analysis before investing any money you will minimize you risk - but you will never eliminate it.

Risk derives from a number of factors - most of which are out of your control. Consider the following risks:

Business Risk:   Business risk refers to the possibility that the management team of the company you invest in may not perform at a level that is adequate to generate a good return on your investment.

Individual Stock Risk:   If you invest all of your money in a single stock, you are exposing yourelf to greater risk than if you invest in a diversified portfolio of stocks in different industries. Through proper diversification, you can reduce much of this risk.

Market Risk:   There are occasions when the entire market declines precipitously. When this happens, it is likely that irrespective of the stocks you have picked, your investments will suffer.

Liquidity Risk:   Liquidity risk refers to the fact that while markets are generally well-behaved, you may not always find a cadre of willing investors to take your shares off your hands at a reasonable price at the time you are ready to sell.

Interest Rate Risk:   If you invest in fixed-income securities, such as preferred stocks or bonds, you will be exposed to interest rate risk. Prices of these securities will move inversely to changes in interest rates.

Inflation Risk:   Stocks have generally proven to be a good hedge against inflation. Historical returns on stocks have typically outpaced inflation by a fairly wide margin. However, this is not always the case. There have been occasions when the economy (and stock prices) have lagged while inflation has raged.

Taxation Risk:   Tax laws are continually changing. And with these changes come additional risks relating to how your dividends and capital gains will be treated from a tax perspective.

While it is important to understand these risks, they should not necessarily deter you from investing wisely in the stock market. Most financial experts agree that in order to achieve a comfortable retirement, most people would be wise to invest at least a portion of their discretionary income in stocks.

How Stocks are Valued

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