Investing in stocks can prove rewarding. But first things first: Risk accompanies any investment.
It is important to understand that loss is a realistic possibility, especially when investing in a start-up company. And many early-stage companies do indeed fail, and leave investors with nothing.
Risk involves circumstances or developments beyond your control. The value of a given investment may increase or decline because of changes in market conditions or due to events in a given region – shifts in geopolitics, economies or currencies, among others. Of course, a company’s strategic decisions, such as acquisitions, may pose risk.
A savvy investor should also consider additional forms of risk – namely liquidity and concentration. Liquidity risk involves the relative difficulty (or ease) of cashing out an investment should you need to, while concentration risk involves the degree to which your investments are held in a single or small number of securities. If, for example, you have a high percentage of your holdings in a single company, your investment outcomes are largely dependent on that individual stock’s performance.
In sum, risk represents the prospect of a negative result – one that could hinder your personal finances.
Against that backdrop, it is important that investors develop a financial plan before taking on risk. They should decide how much they can afford to lose, in a worst-case scenario, to help inform the amount they choose to invest. They should know the duration of time they intend to stay invested in a stock, and their ultimate investment goals.
With these considerations and objectives top of mind, investors can delve into the all-important research phase – why choose one stock over another? What are the important geographic, economic and industry-specific circumstances that could impact a given company?
All of that noted, with risk comes the potential for reward – that is, the possibility of higher returns. Historical SEC data show that those with long-term financial goals who invested in stocks enjoyed the strongest average annual returns – more than 10 percent per year.
Corporate bonds trailed at about 6 percent annually, followed by Treasury bonds, and then cash in bank savings products or cash equivalents such as short-term Treasury bills.
In short, history suggests you can make more money, over time, by carefully investing in asset categories with greater risk. But a wise investor must also brace for the downsides that may accompany a higher level of risk.
*Nothing in this article should be considered legal or investment advice. Startup investments are always inherently risky and following the advice in this article will not necessarily reduce that risk.