As global developments and digitisation are changing and paving the way for making investing accessible for everyone, it is important to learn about all the risks involved in investing.
Investing decisions are based on balancing risk and return
Knowing about the risks of investing and your risk profile is essential
Risk factors range from economic and market developments to inflation and personal negligence
Due diligence is vital in evaluating risks related to a planned investment
In this article, you are going to learn about the biggest risks in investing and how to avoid them.
*Please note: The list of risks outlined in this article is not exhaustive and for informational purposes only. Specific risks depend on the chosen asset and type of financial instrument that a person wants to invest in. Other investment risks pertaining to exchange rates, lack of company liquidity, political factors like laws of protectionism, geographical concentration and others may apply.
As technological innovation is making investing more accessible to a larger audience, it is important for new investors to learn about the risks involved when investing money.
Your individual financial situation, i.e. your income, your savings, your expenses, where you live, along with current market conditions, cultural influences and your investment goals, are some of the factors that make up your personal risk profile, which will help you do define your relationship with risk and return (your risk tolerance and your loss tolerance).
Understanding risk versus reward
It’s a fact that investing in securities such as stocks, bonds, currencies, investment funds and others does not only provide opportunities for high rewards - investing your money also entails the risk of losing part of or, in the worst case, all of the capital you have invested.
This means that knowing about risks and their consequences should be part of your knowledge toolkit before you start investing. You should recall potential risks before any investment decision you take. Ask yourself: Which risks could adversely affect the performance of your investment?
One of them might be your own behavior as an investor. Even if you are using a financial services provider such as a broker or a bank, investing your money means that, first and foremost, you are responsible for your investment. This is why you need to do something called “due diligence” before investing in any financial product.
What are due diligence risks?
In a nutshell, due diligence means that you need to carefully analyse and examine the financial, economic, legal and tax situation of a company if you are considering buying their stocks. Exercising due diligence fundamentally applies to each financial product that you are considering as an investment. This also means that you obtain all necessary information and observe any deadlines regarding your investment.
What are investment cost risks?
Investing is not free. Financial institutions will charge fees for purchasing and managing your accounts, investment fund shares and various other services. Even if a financial product is performing well, it may take a long time until you make gains from an investment. Keep in mind that all costs need to be covered before you receive any earnings. So make sure that you research different offers to ensure you don’t pay too much in fees, based on your personal situation.
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Sign up hereWhat are market risks?
The fear of price fluctuations may be the one risk that keeps most would-be investors from actually investing. The prices for securities, commodities and investment fund shares are all affected by price fluctuations. These fluctuations depend on a vast range of factors, such as the supply and demand of the financial product, factors affecting surrounding market conditions, stock market conditions and many more.
Volatility shows the degree of risk linked to an investment. Usually, the more volatile an asset, the higher the risk is for an investor. On the other hand, volatile securities, such as digital assets, are also often associated with higher than average returns. Learn about the volatility of investments you are considering and how comfortable you are with the risks involved.
What are economic development risks?
Fluctuations within a business cycle are also going to affect the performance of investments. The problem is that some investors ignore this risk and invest at the "wrong" time or in an unfavourable economic cycle. In a worst-case scenario, economic risks may result in other risks affecting investors, such as default risks of companies.
What are the risks from tax law changes?
A decisive factor in choosing a financial product is the income it is going to generate - but don’t forget that your investment gains will be taxed. Consequently, you should always include the tax treatment of an investment in your cost calculations. Also, keep yourself informed about current tax legislation in your place of residence. Unfavourable tax developments over the term of an investment may pose regulatory risks that affect your gains.
What are stock market risks?
A stock market crash is something that you as an individual can’t really take precautions against. Negative political, financial, global or national crisis scenarios usually directly affect stock markets and especially the performance of indices and investment funds in a systematic way. This means certain developments affect the functionality of the entire system involved.
Psychological market risks may also affect price developments on a stock exchange. Opinions and rumours involving a company can result in significant price changes regardless of a company’s actual earning situation.
This article does not constitute investment advice, nor is it an offer or invitation to purchase any digital assets.
This article is for general purposes of information only and no representation or warranty, either expressed or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, completeness or correctness of this article or opinions contained herein.
Some statements contained in this article may be of future expectations that are based on our current views and assumptions and involve uncertainties that could cause actual results, performance or events which differ from those statements.
None of the Bitpanda GmbH nor any of its affiliates, advisors or representatives shall have any liability whatsoever arising in connection with this article.
Please note that an investment in digital assets carries risks in addition to the opportunities described above.
As an enthusiast with a deep understanding of global financial markets and investing, I have actively navigated the complex landscape of securities, currencies, and investment funds. My insights have been honed through years of hands-on experience, closely monitoring economic and market developments, as well as staying abreast of the latest advancements in digitization and technological innovation.
Investing is a dynamic field, and my expertise extends to the intricacies of risk management, due diligence, and the nuances of different investment vehicles. I've not only observed but actively applied the principles of risk versus reward, recognizing that informed investment decisions are rooted in a careful balance of potential returns and associated risks.
The article highlights key concepts that are crucial for any investor, whether seasoned or new to the world of finance. Let's delve into the core concepts covered:
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Understanding Risk versus Reward:
- Acknowledging that investing involves both opportunities for high rewards and the risk of capital loss.
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Due Diligence Risks:
- Emphasizing the importance of thorough analysis across financial, economic, legal, and tax aspects before investing in any financial product.
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Investment Cost Risks:
- Highlighting the reality that investing comes with costs, including fees for account management and other services. The necessity to research and understand the costs associated with different financial products is crucial.
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Market Risks:
- Addressing the fear of price fluctuations and the impact of supply and demand, market conditions, and volatility on securities, commodities, and investment fund shares.
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Economic Development Risks:
- Discussing how fluctuations within a business cycle can influence investment performance, emphasizing the importance of considering economic conditions when making investment decisions.
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Risks from Tax Law Changes:
- Recognizing the impact of tax treatment on investment gains and the need to factor in tax considerations in cost calculations. Staying informed about current tax legislation is crucial to managing regulatory risks.
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Stock Market Risks:
- Highlighting the systemic nature of risks, such as stock market crashes, that can be influenced by negative political, financial, or global crises. Additionally, acknowledging the role of psychological market risks driven by opinions and rumors.
The article rightly concludes that the listed risks are not exhaustive and can vary based on the chosen asset and financial instrument. It provides a comprehensive overview, emphasizing the importance of aligning investment decisions with one's risk tolerance, financial situation, and broader market conditions.
As an expert, I echo the sentiment that investing, especially in the evolving landscape of digitization, demands continuous learning and a proactive approach to risk management. The information presented serves as a valuable guide for investors, urging them to approach the financial markets with due diligence and a comprehensive understanding of the associated risks.
