Blog Details

...

Investing in Stock Market

Articles | 15 Dec, 2022

Stock investments are one of the best ways to generate wealth. Every investment has some form of risk associated with it. The investment world works on a simple principle of risk-reward: higher risk offers a better possibility of earning higher returns and vice versa.

Therefore, stock investments carry certain risks that all investors need to be aware of. Today, I will be talking about the risks associated with making a stock market investment and how you can manage those risks efficiently.

Risks Associated With Stock Market Investments

Market Risk:  The price of a stock is determined by the demand and supply of the said stock in the share market. Hence, it fluctuates every day and within the day too. As an investor, you buy stocks and earn gains either through the dividends declared by the company or by selling them at a higher price. However, when you need to sell the stock, if the price is low, then you stand the chance of booking losses. This is market risk.

Liquidity Risk: Liquidity is a term used to refer to how easily an asset or security can be bought or sold in the market. It basically describes how quickly something can be converted to cash. There are two different types of liquidity risk. The first is funding liquidity or cash flow risk, while the second is market liquidity risk.

Taxability Risk: The government changes taxes all the time and hence taxes may increase or decrease in the particular industry where you invested. The change in taxation can affect the stock price.

Company Risk: A share is a piece of ownership in the company. If the company faces problems in business, then the stock price can fall. Most investors analyze the financials and management of the company before investing in its stock. Hence, a problem there can lead to a price drop.

Interest Rate Risk: The government also changes the interest rates on deposits and loans based on the direction in which the economy is headed. Hence, if the interest rates increase, companies get loans at higher rates that can cut into their profits and affect the stock price.
On the other hand, if interest rates fall too low, then it is an indication of a slowdown in the economy, and businesses suffer losses too. Hence, a balanced interest rate regime is healthy for the stock markets.

Regulatory Risks: There are a number of regulations imposed in the different industries which must also be termed as the risk involved in stocks. For example, Cigarettes, telecommunication, beverages, pharmaceutical and a few other industries are highly regulated.

Inflation: With an increase in inflation, the price of raw materials will increase, which can affect the production cost. Many companies involved in commodities like oil, soya bean etc are affected a lot by inflationary risk.

Managing Stock Investment Risks

Diversification: Diversification is a technique that reduces risk by allocating investments across various financial instruments, industries, and other categories. It aims to minimize losses by investing in different areas that would each react differently to the same event. 

Diversification is effective when you invest in stocks of companies that have zero or low correlation with one another. In simpler terms, invest in market segments in a manner that if one segment falls, then the other does not automatically fall too.

Research the Company Before Investing: Another good way of managing the risk of investing in stocks is to ensure that you research the company well before buying its stock. Look at the company’s financials and assess if it is sound enough to weather the economic ups and downs.

Avoid Emotion-based Investment Decisions:  The investors of today have a lot of information available via news channels, blogs, online articles, etc. While every ‘expert’ claims to help them earn massive returns, getting drawn into an investment without proper research can be counterproductive.

Don’t Invest and Forget; Keep Track: Stock markets are inherently volatile. Hence, if you hold a portfolio of stocks, then there can be times when certain stocks need to be sold and some new ones must be purchased to optimize the returns. You can identify these opportunities if you regularly track your investments. Once a fortnight is good but you can increase or decrease the frequency based on the kind of stocks you have invested in.

Invest According to Your Risk Tolerance:  Now that you have a fair idea about the risks associated with stock investing and the ways in which you can manage them, I would also like to highlight an important aspect that you need to keep in mind while investing – always invest according to your risk tolerance.

Every investor is different and has a different level of tolerance to risk. While someone might be willing to bet on the proverbial dark horse or take high risks with his investment for an opportunity to earn great returns, someone else would be comfortable with lower returns as long as he takes lower risks. It is important to invest according to your risk tolerance levels to keep emotion-driven decisions at bay.

Share Blog

Categories