Investing and risking go hand in hand.
You simply cannot invest in anything without taking a certain amount of risk.
Of course, the main risk that you take is the risk of losing all of your money.
But since this is low, most of us refer to risk as to the prospect of our investments significantly declining in value.
And that’s a more realistic risk. If you’re an investor, you must be ready for it.
But simply being ready for it isn’t enough. You must also ensure that you minimize it as much as you can from the start.
If you’re a beginner when it comes to stock market investing in particular, there are all kinds of ways to minimize the risk of losing money.
So, let’s see what the 3 main risks of stock market investing are and how you can manage them…
1. Business Risk
Business risk is simply the risk that the company you have invested in faces some challenges regarding their business operations.
This could be that they fail to reach earnings forecasts repeatedly.
Or maybe they’re unable to cover their yearly obligations.
It could also be that they can’t pay the interest on their loans in time.
Any of these factors could affect the business negatively and scare investors away.
A lot of selling may occur when analysts stop recommending the stock because of these factors. Thus, driving the value of your investment down.
A very good fix for this is what is commonly called “diversification”.
Diversifying your portfolio is about owning enough stocks so that one falling from glory doesn’t impact your overall performance.
You don’t necessarily have to buy dozens of stocks. That would actually decrease the chances that a high-performing stock significantly affects your performance.
Instead, just aim for 20 to 30 stocks and make sure that you have invested an equal amount of money (more or less) in each one of them.
2. Industry Risk
Industry risk is not much different than business risk.
The main difference is that it is about the average business performance of a certain industry; so not something that a company has control over.
Industry risk can involve more industry regulations, higher taxes, or generally something totally unexpected that happens within an industry that affects the majority of the businesses of it negatively.
The solution to this is similar to the one concerning business risk; you must diversify.
But instead of adding more stocks to your portfolio, you must buy stocks belonging to different industries.
If you hold 20 to 30 stocks, then make sure that no more than 2 or 3 belong to the same industry.
3. Market Risk
Market risk is a factor even further away from a company’s control.
It’s about the potential danger that the stock market as a whole will decline in value. This risk is usually realized in a recession where massive selling of stocks occurs.
It may be getting boring, but the same risk management solution applies here as well; diversification.
But here’s the twist…
Instead of adding more stocks from different industries, you buy more than stocks. I’ll explain.
Stocks constitute one of several asset classes. Some other equally common ones are bonds, real estate, commodities, treasury bills, etc.
So by investing in both stocks and other asset classes, you can minimize the impact a recession can have on your portfolio.
You don’t have to invest in all of these asset classes to lower market risk of course. You only need to pick one more so you can protect your money during market downturns.
A common strategy is 50% of your portfolio to consist of stocks and 50% of bonds.
But others prefer an 80 – 20 approach (80% stocks, 20% bonds) or the reverse depending on their age.
Speaking of age…
There is a popular strategy of decreasing the amount of money invested in stocks and increasing the amount of money invested in bonds as you grow.
It’s based on the view that as you grow older, you can take lower and lower risk. And the stock market is generally more volatile than the bond market.
But volatility has been used to mean risk unnecessarily. Who cares if we are going through a crisis? The stock market has proved that it can always recover and keep growing over the decades.
It all comes down to whether you can stand seeing your portfolio’s value freefalling during an economic recession. The only risk during one is that you panic and sell.
If you think you are likely to do this, then also investing in bonds to lower the impact of the stock market’s decline definitely seems like the wise choice here.
But if you think that this is unlikely and you can suffer witnessing your portfolio’s value moving erratically during hard times, then you don’t really need to protect yourself from market risk.
The risk along with the financial damage doesn’t become real unless you sell.
Conclusion
As you can see the main stock market risk is losing money. But there are 3 main factors that can lead to it:
- Business risk
- Industry risk
- Market risk
All of the types of risk in stock market investing are unpredictable.
You cannot really prepare for them by liquidating your position before it happens. Actually, doing that because there are indicators of upcoming catastrophes will not treat you well in the long run.
What you could do instead is diversifying across different companies, industries, and asset classes and keep investing.
I hope this article helped you understand the main risks of stock market investing and how you can manage them. If it did, please take a second to share it with others!
Also, if you have any questions, just leave a comment below and I’ll get back to you.
Thanks for reading and I wish you long-term success in investing!
Disclaimer: This information should not be viewed as financial advice. You should consult a financial advisor or do your own due diligence before you invest. The owner of this website and author of this article are not to be held liable for any undesired result by anyone who uses this information that is provided here in any way.
