Every financial investment carries risk. And while conventional wisdom says that you could earn a higher return by taking on more risk, veteran investors will tell you that learning how to manage that risk is the steadiest path to making a profit. Here’s a roundup of common types of risk that affect investments and how to position your long-term investments for success.
A financial advisor can help you create a financial plan based on your risk tolerance.
Understanding the Risks of Investing in the Stock Market
Many Americans invest in the stock market, but not all of them understand the risks involved. Here’s a breakdown of six common types of risk that could affect your investments:
Business risk. Business risk refers to the level of uncertainty and potential financial loss that is associated with investing in a specific company’s stock or equity.
This risk can include underperforming earnings reports that are due to changes in leadership, quality management, competitive positioning, industry conditions and financial stability.
Downside risk. Downside risk estimates the potential decline in value for investments like stocks, bonds and other assets due to market-related factors and fluctuations.
Changes in supply and demand, economic conditions, investor sentiments, company-specific events and broader market trends are considered downside risks.
One example of a downside risk can come from holding a large position in a high-risk sector. If this sector experiences a market-wide downturn, the value of the holding will decline significantly.
Economic risk. Economic risk refers to the potential of financial losses or reduced returns stemming from macroeconomic factors and events that affect the broader economy, financial markets and investments.
One example of economic risk could come from a recession as it can affect a company’s sales and profitability, which could consequently lead to a decline in its stock price.
Other examples of economic risk include interest rates, currency fluctuations and geopolitical events.
Inflationary risk. Inflationary risk can undermine the real value of investment returns and the purchasing power of investors.
It refers specifically to the risk of inflation outpacing the returns of investments, which causes a decrease in the actual (inflation-adjusted) value of assets over time.
Inflationary risk can have a substantial impact on fixed-income investments like bonds, as well as cash holdings and other assets that fail to provide adequate protection against the erosion of value caused by increasing prices.
Political risk. Political risk refers to the negative impact on investments due to political events, instability or policy changes in a specific country or region.
Changes in government leadership, shifts in political ideologies, regulatory modifications, trade disputes and geopolitical conflicts are considered political risks.
One example of a political risk can stem from the sudden imposition of trade tariffs by a government, which can disrupt global supply chains and negatively affect the stock prices of companies reliant on international trade.
Political risk can disrupt stability and investment profits, including stock holdings, business operations and assets located in affected areas.
Risk of being too conservative. Being risk-averse makes sense when you want to protect your portfolio. But a conservative asset allocation can also put your long-term investments at risk.
Investors who are too conservative can fall short of their objectives, especially when higher returns from riskier assets like equities are needed to reach retirement savings or wealth growth goals over extended investment horizons.
Investing the majority of your portfolio in low-risk, low-return assets like cash, bonds or stable dividend stocks can also fail to protect against economic risks like inflation.
Tips for Long-Term Stock Investing
Here are five common tips for successful long-term stock investing:
- Diversify your portfolio: Spread your investments across different sectors, industries and asset classes to reduce risk. Diversification helps protect your portfolio from the poor performance of a single stock or sector. Consider a mix of growth stocks, value stocks and dividend-paying stocks to achieve a balanced portfolio.
- Invest long term: Focus on a long-term investment horizon, typically measured in years or decades. Don’t react to short-term market fluctuations or don’t time the market. History shows that long-term investors tend to benefit from the compounding of returns.
- Research and choose quality stocks: Conduct thorough research before investing in individual stocks. Look for companies with strong fundamentals, such as a competitive advantage, solid financials and consistent growth prospects. Consider factors like a company’s management team, market position and growth potential.
- Practice patience and discipline: Stay patient and disciplined in your investment approach. Avoid making impulsive decisions based on emotions or market noise. Stick to your investment strategy, and if necessary, make adjustments based on your long-term goals, not short-term market trends.
- Review and rebalance your portfolio periodically: Examine your portfolio regularly to make sure that it aligns with your long-term objectives and risk tolerance. You can rebalance your portfolio by buying or selling assets to maintain the asset allocation that fits your needs. This will help you keep pace with your investment goals.
Bottom Line
Investments carry risks without guarantees for positive returns. Consider your risk tolerance, time horizon and financial goals when building and managing your portfolio. Additionally, research different types of risk associated with your investments and seek professional advice to inform your investment decisions.
Investing Tips for Beginners
- If you want to grow your investment portfolio and protect your money from risk, a financial advisor can help you create a financial plan for your needs and goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s asset allocation calculator can help you figure out the allocation that makes the most sense for your retirement portfolio.
Photo credit: ©iStock.com/recep-bg, ©iStock.com/gpointstudio, ©iStock.com/ , ©iStock.com/mdphoto16
