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Risks Of Investing In Stocks – Fallible Aspects Of Stock Investing

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Introduction

As you can tell from the various lessons here at Invest In Wall Street, the words of wisdom from legendary billionaire investors, seems to keep popping up just around every corner. They are able to do what 99% of what all investors fail to do – minimize risk on their investments, they are billionaires for a reason, after all. But perhaps the quote from multimillionaire, Robert Kiyosaki, the author of the best-selling novel, Rich Dad Poor Dad, perfectly sums up what the topic of today’s lesson, which is the risks of investing in stocks. By the end of this lesson, you will fully understand the risks of investing in stocks – along with proven techniques you can use in order to thrive in the stock market.

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

Stock Investing Risks

Whether you’re new to stock investing or a seasoned pro, one of the most important aspects to consider is risk. One of the primary stock investing risks is market risk. This risk stems from the correlated nature of the stock market.

Market Risks

Simply put, all stocks tend to move together in some degree. So market risk is the risk that the overall stock market could trend lower, decreasing the value of any stocks that you own.

One way to monitor market risk is by watching the trend in a broad stock market index, such as the S&P 500. Keeping an eye on the trend can help you make strategic decisions if the markets seems to be entering a new uptrend or downtrend.

For example, if the S&P 500 begins down-trending, some investors might reduce market risk by selling stocks and moving proceeds into cash – until the index starts a new uptrend.

 

Sector Risks

In addition to market risk, stock investors need to consider sector risk. This is the risk of bad news affecting an entire sector, and impacting many of the companies within that sector.

For example, suppose new legislation restricts energy consumption. This news can hurt many businesses in the energy sector, decreasing stock prices.

One way to help manage this risk is to diversify across a wide range of sectors. This way, if bad news impacts one sector, only a portion of your stock investments would suffer. The last stock investing risk we’ll discuss is business or company risk.

To read more about Stock Sectors, check out my Stock Sectors post:

Stock Sectors – Choosing Among Leading Industries

You may also want to check out….

Diversified Portfolio Stocks – The More The Merrier

Company Risks

This risk encompasses all the risks that come with investing in an individual stock, such as disappointing earnings or sales, a change in leadership, emerging competition, or new regulations.

The most dangerous form of company risk is bankruptcy risk. This is because if a company goes bankrupt, its stock will lose all of its value.

One way to help manage company risk, including bankruptcy risk, is to carefully position size. A position size is the dollar amount invested in a stock relative to the size of your overall portfolio.

For example, an investor might use a trading rule that prohibits them from investing more than 5% of their portfolio in a single stock.

To give you an idea of what this looks like, lets assume this investor has a portfolio of $100,000 – and wants to invest in stock XYZ.

To manage their risk, our investor would limit their purchase to 5% of their entire portfolio, or $5,000. If XYZ is currently trading at $50 per share, our investor can buy a maximum of 100 shares.

Next, they can use limit/stop orders on this position to potentially limit their losses.

Let’s say they’re willing to lose no more than 1% of their total portfolio, or $1,000 on any one position. They could then set a stop at $40. This is a loss of $10 per share, or $1,000 for the whole position.

Ideally, if the position plummets, the stop order would trigger, and likely help reduce their losses to 1% of their portfolio, a relatively small and manageable setback.

To read more about Position Sizing, check out my Position Sizing post:

Portfolio Position Sizing – Accurately Measuring Your Positions

Using strategies such as monitoring the trend of the broader stock market, diversifying across sectors, and limiting position size, are just a few ways to manage the risks of stock investing.

But remember, stocks are just one asset class investors can include in a portfolio.

One way to further manage your overall portfolio risk is to allocate investments across other asset classes such as bonds, commodities, and real estate – as this could help offset risks unique to stocks and potentially lead to more stable returns in the long run.

Oh And Quick Fun Fact…..

The video that I chose for this post is not just for s*?ts and giggles, as there is a deeper meaning that relates to today’s lesson. In case you are confused, I will explain the analysis further detail. Prepare to experience a mind f!*k

Bart Simpson = The Investor

The 98 cent store = An Abstract Metaphor Of The Stock Market

Items In Shopping Cart = Various Asset Classes – Such As: Stocks, Bonds, Mutual Funds, ETFs, Derivatives, ect. The shopping basket is the investment portfolio – as investors tend to shop for financial assets like they shop for groceries

Candy =  Underlying Themes Of Today’s Lesson- Which Is Diversification & Asset Allocation

Ice Cream Employee = US Government

And for those of you who are especially observant…..

If you pause at exactly 0:45 seconds, you will notice that there is a “TIPS” jar near the cash register. This is a reference to a previous lesson here at Invest In Wall Street. TIPS are essentially Treasury Inflated Protected Securities – hence the acronym TIPS – and is a specific type of T-Bill. You can learn more about TIPS and similar assets in our Bonds & Fixed Income Investments Course, here at Invest In Wall Street.

The employee in the ice cream store is a facade that represents the US Government (Uncle Sam). As you may already know, the government can raise funds by issuing bonds. The kicker here is that the government is disguised as a teenager working in a candy store and is asking for handouts – yet Bart Simpson only gives him a single penny – a drop in the bucket compared to the BILLIONS of dollars needed to run the country efficiently.

Now that you understand the deeper meaning and analysis to this video clip, I want you to watch it one more time – as viewing it will never be the same…..

Quick Recap

In Review…..

Types Of Stock Market Risks

  1. Market Risk – is the risk that the overall stock market could trend lower, decreasing the value of any stocks that you own
  2. Sector Risk – is the risk of bad news affecting an entire sector, and impacting many of the companies within that sector
  3. Business/Company Risk – This risk encompasses all the risks that come with investing in an individual stock, such as disappointing earnings or sales, a change in leadership, emerging competition, or new regulations. The most dangerous form of company risk is bankruptcy risk. This is because if a company goes bankrupt, its stock will lose all of its value.

Reducing Stock Market Risk

  • One way to monitor market risk is by watching the trend in a broad stock market index, such as the S&P 500. Keeping an eye on the trend can help you make strategic decisions if the markets seems to be entering a new uptrend or downtrend
  • One way to help manage sector risk is to diversify across a wide range of sectors. This way, if bad news impacts one sector, only a portion of your stock investments would suffer
  • One way to help manage company risk, including bankruptcy risk, is to carefully position size. A position size is the dollar amount invested in a stock relative to the size of your overall portfolio
  • Using strategies such as monitoring the trend of the broader stock market, diversifying across sectors, and limiting position size, are just a few ways to manage the risks of stock investing
  • One way to further manage your overall portfolio risk is to allocate investments across other asset classes such as bonds, commodities, and real estate – as this could help offset risks unique to stocks and potentially lead to more stable returns in the long run

And these are the main risks involve din investing in stocks. As you already know, stocks are highly liquid and are historically volatile – but are still popular investments because of their high growth performances and returns (ROI).

There are risks involved in this investment – just like any other asset – and the main ones that we discussed in today’s lesson are: Market Risk, Sector Risk, and Business/Company Risk.

There are a variety of measures you can use to help minimize the risk of losing all of your invested capital of course – but some of the best ways to do this, are considered to be the easiest and simplest ways of doing so, such as: monitoring general trends of major indices, diversifying across various sectors, applying position sizing and, allocating your portfolio to other investments besides stocks (Bonds, Mutual Funds, ETFs, Derivatives, Real Estate, ect.).

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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