Seven Things All New Investors Should Know About Risk

Investing can be a great way to make money, but any investment comes with a certain degree of risk.

Therefore, as a new investor, you should understand the different risks associated with investing before you begin doing things like buying stocks and shares.

Here are seven important things that you should know about risk.

1. Taking Risks Can Lead to Both Better and Worse Outcomes

Novice investors often think that the more risks you take, the higher returns you can get. But things aren’t quite as simple as that.

As you take more risks with your investments, the range of potential outcomes increases. That means the best potential outcomes get better but the potential worst outcomes get worse.

So, it’s important that you learn how to invest wisely to balance the risk.

2. Your Investments Must Be Able to Survive the Worst Days of the Market

To become a successful investor, your investments need to not only survive average market days. Your investments also need to survive the market’s worst days.

That means you need to build up a portfolio that can withstand occasional battering.

By having sufficient liquidity, you can more easily sail through bad patches.

To survive bad patches, you not only need to invest wisely and build a wide-ranging portfolio. You also need to avoid entrusting your money to fund managers with poor track records.

3. You Need to Understand Margin Loans

Margin lending enables you to borrow funds from your brokerage to invest in securities with a line of credit.

A margin loan is collateralized by your existing portfolio. You must pay back the loan with interest at a later date.

Margin loans can be very useful. For instance, if you invest in SoFi loans and have a balance of $2,000 or more, you’re able to use a margin loan to finance up to 50% of your next investment’s purchase price.

But you need to be aware that margin investing is risky. If your investment’s value decreases, you would still owe the amount you borrowed on margin as well as interest.

If the value decreases too much, you may need to add more money or sell your investments in order to repay the margin loan, which is known as a margin call. 

4. You Need to Know About Business Risk

One of the most well-known types of investment risks is known as business risk.

That means there’s a risk that something could happen to the company you’re investing in.

Things like changes in leadership, poor earnings reports, outdated products, or wrongdoing within the company can all lead to you losing value with your investments.

Furthermore, being able to forecast such risks as those is almost impossible.

So, when you buy stock in a company, you need to be aware of the potential business risk.

The best way to safeguard against this risk is to purchase a put option or set automatic stops.

5. You Should Be Aware of Call Risk

With some bonds, companies have the option to call back or repay bonds early.

That typically happens when they have to pay a higher coupon on a bond than they would have to pay at current interest rates.

While call risk won’t cause a loss of principal, if you rely on a certain coupon rate, you could experience a significant loss in income.

If you rely on coupon income for your immediate living expenses, a good diversification strategy is to invest in ETFs, bond funds, or noncallable bonds.

6. Dividend Risk Is Another Risk You Need to Know About

Dividend risk refers to the risk that a company will reduce or cut its dividend.

If you rely on stock dividends to fund your retirement, you are particularly at risk in this scenario.

But as long as you hold a good diverse portfolio that has multiple dividend-paying stocks, you can reduce this risk.

If you’re only holding stock for dividend purposes, you should sell it as soon as you’re able after a company has announced the change in its dividends.

7. Keep Political Risk in Mind

Before you invest in commodities like oil, you need to be aware of political risk. That means political things happen on the world stage that affect investments.

For example, in the past, terrorist attacks on oil pipelines caused volatility in the oil market and other commodity markets.

Political risk is difficult to predict and avoid, as events tend to happen with no warning. But if you do invest in commodities that are at risk from potential political risk, having excellent exit points and FX Hedging strategies can help you ride out political storms.

Final Thoughts

Don’t let the above risks put you off investing.

A key part of successful investing is understanding the potential risks.

The more you familiarize yourself with the risks, the savvier you can be about your investments and make the right choices to get a healthy return on your investments.