Investments, in general, come with risks, but well-considered investment choices that meet your goals and risk profile keep the risks of individual stocks and bonds at an acceptable level. However, there are other risks that you have no control over that lie in the investment. Most of these risks affect the market or the economy and require investors to adjust their portfolios or weather the storm.
Economic Risks
One of the most apparent risks in investing is that the economy can deteriorate at any given moment. After the market collapse in 2000 and the terrorist attacks on September 11, 2001, the economy settled into a tough period, and market indicators saw relatively significant losses. It took years to return to levels close to pre-September 11 marks, only for the market to collapse again in the 2008 crisis.
For younger investors, the best strategy is often to shelter and endure these downturns. If you believe in the long-term returns of financial markets and are liquid during times of crises, you can use temporarily low prices to increase your positions in strong companies that perform well in the long term. This means buying more shares of the stocks you love during bad market times.
Foreign stocks can be a positive point when the local market is in a downturn, thanks to globalization, as some American companies earn the majority of their profits from abroad. However, in the case of a collapse like the 2008 crisis, there may not be truly safe places to invest.
Older investors find themselves in a more constrained position. If you are nearing retirement, a significant decline in the stock market can be devastating if you have not shifted substantial assets into bonds or fixed-income securities. For this reason, diversification and adjusting your asset allocation in your portfolio as you age is essential for investing.
Inflation Risks
Inflation is a tax on everyone, and if it is too high, it can destroy value and create recession. While we think inflation is under our control, the remedy of high-interest rates can at some point be as bad as the problem. With massive government borrowing to finance stimulus packages, it is only a matter of time before inflation returns.
Investors typically retreat to fixed assets like real estate and precious metals, especially gold, in inflationary times, as they are less susceptible to changes. Inflation significantly impacts fixed-income investors because it affects the value of their fixed income flow. Stocks are the best hedge against inflation because companies can adjust prices according to inflation rates. A global recession may mean that stocks will struggle for a long time before the economy is strong enough to bear higher prices. It is not a perfect solution, which is why retiring investors should also keep some of their assets in stocks.
Market Value Risks
Market value risks refer to what happens when the market ignores your investment or overlooks it. This occurs when the market goes in pursuit of “the next hot thing” and leaves many good but unexciting companies behind. It also happens when the market collapses because good stocks, as well as bad stocks, suffer when investors flee the market.
Some investors see this as a good thing and consider it an opportunity to buy great stocks while the market is not pricing them down. On the other hand, it does not help your case to watch your investments plateau month after month while other parts of the market rise.
Don’t fall into the trap of putting all your investments in one sector of the economy. By diversifying your investments across several sectors, you have a better chance of participating in the growth of some of your stocks at any given time.
Risks
Excess Caution
There is nothing wrong with being a conservative or cautious investor. However, if you don’t take any risks, it may be challenging to achieve your financial goals. You may have to fund 15-20 years of retirement from your retirement egg, and keeping it all in low-interest savings tools may not be enough. Younger investors should be more aggressive in their portfolios, as they have time to recover if the market turns sour.
Frequently Asked Questions (FAQs)
What is gamma risk in the stock market?
Gamma risk refers to one of the “Greeks” that options traders use to analyze options contracts. Gamma measures another volatility known as delta. The higher the gamma, the more sensitive the option is to changes in the price of the underlying stock. This usually occurs when the option is near the money. Options with low gamma are likely either deep in the money or deep out of the money.
What is an exchange-traded fund (ETF)?
There is no single index that tracks stock market risk since there are many different types of risk. However, there is a volatility index that tracks the volatility in the S&P 500 and can be considered a general measure of market risk. ETFs like VXX and VIXY track this index.
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Sources:
R. Barry Johnston and Oana M. Nedelescu. “The Impact of Terrorism on Financial Markets,” Pages 4–7.
U.S. Government Publishing Office. “American Recovery and Reinvestment Act of 2009.”
Source: https://www.thebalancemoney.com/major-types-of-risk-for-stock-investors-3141315
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