Well, there is no simple answer to this question because yes, investing in stocks may pose some risks for investors but not investing in stocks in any form also poses risk.
That is because if one has his/her savings just in the savings bank via a savings account, the interest one earns from that amount is comparatively lower and also is also subject to taxation. With time, the money in the savings account will not be able to beat even inflation and thus, the overall value of the capital will be far less from what one had started.
Although stocks have historically performed well over the long term, it cannot be guaranteed that one will keep earning profits through one’s investment in stocks at every instant. There are a number of things that can be and should be analysed before making a decision to invest in a particular stock.
But even after that, it cannot be said with certainty that the prices will move in the desired direction. So, in this sense, stocks are risky.
Now, let us understand what kinds of risks stocks expose us to. There are mainly two types of risks:
Systematic Risk or Market Risk
This is the risk of the rapid fall of the overall market. This is a result of external and uncontrollable variables, which have nothing to do with a particular industry or security.
It affects the entire market leading to the fluctuation in prices of all the stocks. This kind of risk cannot be diversified. The only way of protection against it is to allocate one’s funds in different asset classes like bonds, real estate, etc.
For example: After the market bust in 1999-2000 and the terrorists’ attacks on twin towers in the U.S. in 2001, the whole economy was shaken up. A combination of factors saw the market indexes lose significant percentages and it took years for things to go back to normal.
So, stocks are risky in the sense that no matter how good our analysis before investing was, we cannot control or predict such events.
This risk is associated with a particular stock, company or industry. This is a result of internal factors and can be controlled by diversifying one’s portfolio because this risk is irrespective of the entire market. It does not have a huge impact like that of systematic risk.
For example, The impact of rising in crude oil prices can be seen on stocks of the paints industry. Since the rise in the price of oil, their costs of raw materials rise, their profitability gets affected and hence, a negative effect on the stock prices.
Similarly, the impact of Indian Rupee depreciation against U.S. Dollar can be seen on the stock prices of companies of the IT industry and pharmaceuticals.
Stocks are risky but there are some ways in which we can try to protect our wealth invested in the stock market. Let us have a look at them.
A well known saying that holds absolutely true in the world of stock market investments – “Do not put all your eggs in one basket“. So, although stocks are risky, the risk gets hedged through diversification.
The portfolio of stocks should be created in such a way that contains a balance of stocks differing in the following ways:
Industry – At a particular point in time, it may be difficult for companies of one industry to perform well. While on the other hand, that same time may be the best time to invest in some other companies in a different industry.
For example, energy stocks might slump while technology stocks are rising.
Size of the company – More returns can be earned by investing in smaller companies that have high growth potential. However, just like greater chances of returns, greater chances of risk are also there.
So, one should maintain a balance by investing in small and mid-cap companies as well as stable large-cap stocks according to the kind of risk appetite on has.
Kinds of Stocks – At a high level, there are mainly two types of stocks traded on exchanges: Preferred and common stock. Preferred stocks are those which offer lower risk and returns but do provide a fixed dividend.
Common stocks offer higher risk and return and therefore, a combination of both would make a good balance.
Time Duration of Investment
Stocks are risky if invested for a very short period of time.
It is common to see short-term fluctuations in stock prices due to innumerable factors happening across the world. It is advised to patiently wait for a good duration of time before reaping the benefits of one’s investment by getting a good return on investment.
Therefore, one should invest only that money in the stock market which will not be needed in the near future so as to avoid losses.
Be Well Informed and Get Advice If Needed
In today’s technological era, the latest news is just a few clicks away.
One should keep a close watch on all the news related to one’s stocks and make decisions accordingly. If one is not comfortable with the current level of knowledge one has, then, it is recommended to get advice from professional experts.
Stocks are risky but a professional may help one to reach his/her financial goals with the amount of risk one is willing to take in a particular duration of time.
Be on the Learning Curve
Besides investing in naked stocks, one may also learn the details of derivative trading to hedge one’s risk. Once a person gets comfortable with the knowledge of calls and puts options and how they work, he/she may find extremely safe ways to earn from the stock market.
Options may open a whole new world of opportunities for a person to suit his/her personal needs of growth and risk. Stocks are risky but using options smartly make them less risky.
Before starting to invest, it is highly recommended to make clear strategies on investing, taking profits and cutting losses at pre-decided stop losses. All of this requires great discipline and patience but is a sure shot way to earn from stocks in the long run.
After discussing various kinds of risks that stocks expose us to, one may say that stocks are risky. But at the same time, it is imperative to know that those risks can be hedged to great extents. Ultimately, it needs a lot of discipline, patience and practice to earn from the stock market.
All the best!
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