Investing in stocks can be a very lucrative opportunity, provided the investor makes the most informed bet.
Investing in stocks can be a very lucrative opportunity, provided the investor makes the most informed bet. However, there are certain risks involved as well. While some are inherent in nature, others are acquired due to external influences.
According to Gopal Kavalireddi, Head of research, FYERS – a technology-focused stockbroking firm – there are two broader categories of risks borne out of macro and microeconomic factors – systematic and unsystematic risks.
Systematic risks are undiversifiable and exist due to political, social, or other macro-economic factors, which are beyond the control of investors. These risks cannot be eliminated and are common for the entire segment of investments.
Here are major kinds of systematic risks:
As per Kailashnath Adhikari, managing director, Governance Now - a Sri Adhikari Brothers Enterprise - one may instantly make a lot of money while investing in stocks and loose out the entire invested principal as well.
This is because there is no ceiling on the upside and downside.
"In order to mitigate the risk, it is very essential that investors understand what they are investing in," suggests Adhikari.
Interest rate risk
Any change in the interest rate of the open market or global market can influence returns either positively or negatively. For example, when interest rates are high, a company may avoid borrowing money.
If the returns of a company are less than the inflation rate, the investor is considered making losses. For example, if the inflation is 8 percent per annum and the investor is making 6 percent returns per annum, he/she is making negative real returns.
Unsystematic risks, on the other hand, are diversifiable and arise due to micro economic factors. The common form of unsystematic risk is business and financial risk. If the business of the company is not doing well, the returns can be majorly impacted.
"This includes credit risk, supply chain risk, managerial risks, regulatory risks, etc, and are different for various sectors and are within the control of every company," said Kavalireddi.
How to mitigate these risks?
For an investor, the best risk mitigation mechanism, as Kavalireddi says, is to seek out an optimal portfolio diversification strategy through a spread of investments across asset classes, sectors and stocks.
Importantly, some asset classes have a correlation to other asset classes or to other financial events. So if inflation goes up, gold also tends to go up. So having a small allocation to gold in your portfolio could somewhat serve as a hedge against inflation risk.
Similarly, home market risk can be hedged by seeking global investment exposure (though that comes with its own risk: currency). Or short-duration bonds could serve as being fairly immune to interest rate risk.
Then there is one risk that many investors ignore. Says Adhikari: "It is very important that investors study the stock well and then invest. Being ill-informed while investing is the biggest risk as investors are totally unaware of its fundamentals."
He adds that investing basis a tip from someone is highly detrimental as that can lead to complete losses if things go south. "No stock investment is risk-free but one can mitigate the risks basis sound knowledge, study and information."
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