If you want to meet your financial goals, you have numerous ways to do so. One of the options at your disposal is to invest a part of your funds into a stock.
A stock is a security representing the ownership of a fraction of a given company.
If the company’s assets and profits grow, you will earn money based on how big of a portion of the stock you own.
Conversely, if the organization falls on hard times and the value of its assets and shares drops, you stand to lose.
Although many people prefer to stick to more straightforward ways to earn and save cash (e.g., visiting discount sites like Tripplo or opening savings accounts), stocks – over the long run – have outperformed most other investments.
Yet, they are not without issues.
Every stock faces commodity price risk, headline risk, legislative risk, and currency risk.
Here are some of the risks you need to consider before investing in the stock market:
Commodity Price Risk
When you buy a stock, you are essentially buying a piece of a company that is subject to commodity price risk.
The prices of the raw materials used by the company to produce its products and services can go up or down, impacting the firm’s profitability.
For example, if you invest in a steel company, a drop in iron ore price would negatively affect the organization’s bottom line and, in turn, the value of your investment.
The same applies to the situation where the price of oil rises because the company’s expenses will most likely rise with it.
As an investor, such circumstances translate into a lower potential return on your investment.
After all, if the cost to make the product rises, you can expect the product’s price to increase as well.
The stock market is a living, breathing entity. It moves with the news and reacts to the events that surround it.
These events include everything from company earnings to major world events, such as war and natural disasters.
Every company is subject to headline risk.
Even if it is unrelated to its operations, a negative news story about the company can result in a sell-off of its stock. It can lead to a decrease in the value of your investment.
For example, if there is a scandal involving the CEO of the company you have invested in, the stock price is likely to take a hit, at least in the short term. This is why it’s crucial to choose your stocks carefully — so that if the market collapses, you won’t be one of those who lose heavily.
A big reason why many people decide to deposit their money into a savings account is that they fear the legislative risk, i.e., the chance that their investments could be compromised by changes to laws, regulations, and policies.
Changes in laws and regulations can impact a firm’s profitability.
For example, if the government imposes new environmental regulations that are costly for a company to comply with, the firm’s profits may suffer.
It, in turn, could lead to a drop in the stock price.
Every company that operates in the international market has to deal with currency risk.
When a company sells its goods and services in foreign markets, it is exposed to fluctuations in the currency’s value used to pay for its products.
As a result, changes in exchange rates can impact the value of your investment.
If you are an American investor and buy shares of an Australian company, your investment will be exposed to currency fluctuations.
The Australian dollar may strengthen against the U.S. dollar (in which case the value of your investment will drop) or weaken against the dollar (and the price of your investment will rise).
Interest Rate Risk
Interest rate risk relates to the interest rates charged by banks and other lending institutions on loans, mortgages, and credit cards.
As these rates go up, the price of a stock usually declines.
Imagine you own 100 shares of ABC Co., a company that sells sports clothing and athletic shoes.
You’re happy with your investment because ABC has gotten stronger over the last decade.
Thanks to its marketing strategy and strong brand presence, the company has more customers than ever before.
In addition, it pays dividends that have kept your return high.
However, you’ve been monitoring the market for a while and see that interest rates are on their way up. In that case, you might want to prepare for an incoming decline in stock prices.
When interest rates rise, stock prices usually fall as investors move their money into bonds and other fixed-income investments that offer higher yields.
On the other hand, when interest rates fall, stock prices usually rise as investors move their money out of bonds and into stocks in search of higher returns.
The Bottom Line
Investing in the stock market is a tricky business.
Just because you are interested in investing doesn’t mean that you’ll have the skills and perseverance necessary to reap big rewards in the stock market.
You need to take into account many risks when investing in the stock market.
If you’re not prepared for these, you stand to lose a lot of money.
This is why you should always do your research. It is the best way to mitigate risks and earn maximum profits.
In the short term, fluctuations in stock prices are inevitable. However, in the long term, stocks tend to offer excellent returns.
You should select only the investment opportunities where you’re willing to ride out the highs and the lows for a longer time.