Individuals who want to invest in equities need to understand the risks associated with investing. Investing in shares and or stocks can be highly lucrative and can set you up for a bright financial future. However understanding the risks and benefits associated with buying shares is a crucial step for your education in the sector of investment.
What are the Risks of Investing?
Investing in shares, like any investment, comes with a certain amount of risk. Shares are often described as ‘high-risk asset classes’ when compared with other types of investments. The primary risk of investing in shares is that it can result in loss of capital. Unexpected events outside of your control or negative developments within the company can significantly affect share prices and the value of your portfolio. In saying that, this is not to scare you away from investing in shares, but merely a necessary understanding that all investors must have.
How Can I Reduce the Risk of Investing?
Today I’ve got to tell you that there are of course ways to reduce the risk associated with investing in shares. The following are common measures that investors should have in place to control the risks associated with buying shares. Keep in mind that this is general advice only and may not be suitable for your personal circumstances.
Diversify Your Portfolio
Not having all your eggs in one basket is a motto that strongly applies when it comes to buying shares. Probably the worst mistake a new investor can make is to not diversify adequately. Diversification refers to making sure an investor has shares in several companies of different industries/sectors/countires etc, thereby reducing the risk relative to the return. The degree of diversification is to the discretion of the investor. For example, if you decide to invest your entire portfolio in a single company dominated by the oil price, a collapse of the oil price will result in a collapse of your entire investment. Hence why it is important to diversify across different industries. Diversification on the share market can take many forms, for example investing in different sectors or different countries or both. For example, a well-diversified portfolio may have exposure to Telecommunications like National Media Group in Kenya, Materials, Financials like Bank of Africa, Bank of Baroda, Stanbic bank etc. Consumer Staples, Information Technology and International, just to name a few all listed on USE. The difficult part is knowing which sectors are most suitable and more importantly which companies within the sector are suited to your investment goals. One of the problems that often arises with diversification is that investors diversify at the cost of understanding their investments. Diversification is an important step when building your own portfolio.
Know What You Own and Know Why You Own It
It is vitally important to understand the company you are buying a share of. These days many investors forget that when they buy a share they are actually buying a part of a business and not just a digital ticker code. Without fully understanding the company’s operations, its financials or future outlook it is very hard to determine if it will be a good investment. The problem arises when you are interested in a firm, however you are unable to fully understand its business model. In order to diversify adequately, you may be forced to look outside your scope of understanding. If you don’t have the time or expertise on how to analyse companies a finance professional may come in useful. Having a professional equity analyst to contact and discuss the company will potentially lead to better investment decisions.
Investors should have along term Outlook
I always tell young investors who seek investment advise that different strategies can lead to success, however in my view, investors have the greatest chance to succeed in the stock market by taking on a long-term approach. An investor’s holding period (how long the investor plans to hold the shares) is crucial when it comes to investing. The shorter the investment horizon, the harder it is to predict the direction of the stock. Market fluctuations are regular, mostly unprovoked and are hard to predict. A common mistake among investors is to sell after a fall and buy after a rise. This results in complete absorption of the fall and missing out on the rise. The rule of thumb is don’t try and time the markets, have long term outlook and invest in good companies.
Try to control your emotions
Emotions are likely the number one challenge investors face on a day to day basis. Media speculation, your Barber’s stock tips, fear of missing out or running with the crowd are all factors that affect our emotions and in turn our investment decisions. Removing emotion from your investment decisions is easier said than done however having an investment strategy and the discipline to stick to it, can reduce the risk of emotional decision making.
It’s much better to buy a wonderful company at a fair price than a suitable company at a wonderful price. – Warren Buffet
The most important point to remember is that there is no secret to successful investing. The only rule is to buy great still developing companies and buy them at the right price because already developed companies have a less vacuum for expansion. This has over time been a proven way to achieve success on the stock market. Being aware of the risks and rewards of investing in the stock market is crucial for the decision making process. There are basic principles that allow you to minimise the risk of investing as outlined above, however there is no way to completely remove risk.
Autonomy to Financial Freedom 