Shares are most times long-term investments that are easy to trade and require only a small amount of money to invest. When the term “shares” is used, it refers to a slice of ownership of one or more companies.
When an individual buys shares from a company, it provides him with goals to develop tailored investment strategies, which include investing for growth, (where you benefit from any increase in value of the shares you own) or two, to investing for income, (where any dividends you receive provide an income stream).
Buying shares from a company is a good investment, however, regardless of how good or successful an Investment might be, it always comes with its risks.
Investment risk is the potential of losing some or all of our money and it is an inherent part of investing. Generally, investors must take greater risks to achieve greater returns; however, taking on additional risks does not always lead to greater returns.
Investors who do not bear risk very well have a relatively smaller chance of making high earnings than do those with a higher tolerance for risk; therefore, it is crucial to understand that there is an inevitable tradeoff between investment performance and risk.
Not all investment decisions will turn out as expected; however, there are specific risks that investors should be aware of when investing in certain asset classes such as buying shares.
Some of these risks include:
The Risk of Capital Loss
This is a general risk that can happen at any time, this is because, when a company is performing poorly or when the market perception of the company is negative, it may be difficult to find a buyer for your shares at the price you want to sell them. Moreover, the share price may fall for low the price, which you originally paid for the share or even to zero.
On the other hand, if the company folds or goes out of business, shareholders may receive only a fraction of their original investment amount or could face the prospect of the complete loss of the amount they invested in the shares of that company. If a company goes out of business, its shares will become untradeable and it is likely to be delisted.
Volatility Risk
The prices of shares can be very volatile and fluctuate rapidly from time to time even within short periods.
This can apply to individual stocks, sectors or to the market itself. Therefore, investors must accept the fact that the value of their shares may fluctuate significantly. Market risk can influence some sectors more than others, thereby affecting the performance of an individual share.
Sector Specific Risk
This is the risk that is associated with a particular sector, which means, only that sector experiences it. For example, the railway industries experiencing terrorist attacks.
Such experiences affect the shares of the investors and existing investors must decide whether they are prepared to weather the storm or whether they should sell their shares in anticipation of further declines.
Exchange Rate Risk
This is another major risk associated with buying shares especially from companies abroad. When you buy shares, after a specific period, you’d bring your profits home to be converted from the foreign currency to your local currency.
Sometimes, investing in a foreign currency leaves you at the risk of losing value when your profit is converted to your local currency, due to movements in the exchange rates between the two currencies.
Timing Risk
Another crucial risk involved with buying shares is buying or selling at a wrong time. Because of market cycles, some shares have a higher degree of risk when the overall share market has risen sharply and is set for a reaction.
In addition, not all sectors of the market follow the same price cycles, therefore it is important to understand business cycles and how different companies perform during different phases of the business cycle as this can help to manage the effects of timing risk.
It is critical that investors understand the effect that these risks can have on their investments.
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