Personal Finance
Lesson 17
5 min

What are the biggest risks in investing?

As global developments and digitisation are changing and paving the way for making investing accessible for everyone, it is important to learn about all the risks involved in investing. 

  • Investing decisions are based on balancing risk and return

  • Knowing about the risks of investing and your risk profile is essential

  • Risk factors range from economic and market developments to inflation and personal negligence

  • Due diligence is vital in evaluating risks related to a planned investment

In this lesson, you are going to learn about the biggest risks in investing and how to avoid them.

*Please note: The list of risks outlined in this article is not exhaustive and for information purposes only. Specific risks depend on the chosen asset and type of financial instrument that a person wants to invest in. Other investment risks pertaining to exchange rates, lack of company liquidity, political factors like laws of protectionism, geographical concentration and others may apply.

Traditionally, personal investment in assets and access to investing used to be a privilege for the few. Would-be investors needed not only a large amount of funds, they also needed access to knowledge about investing and they needed to reside in a country with a regulatory framework which favours personal investment. 

Investor behaviour

Cultural factors also play into investment behaviour. For instance, the majority of Europeans still keep their funds in savings accounts for “hard times ahead”, as having reserves has always been a prominent element of personal finance, placing an emphasis on low risk, partially owing to Europe’s unruly history. 

As global developments and digitisation are changing and paving the way for making investing accessible for everyone, it is important to learn about all the risks involved in investing your money. Your risk tolerance, your investment goals and your loss tolerance and capacity make up your personal risk profile that helps you to define your relationship with risk and return.

Risk versus rewards

It is a fact that investing in securities such as stocks, bonds, currencies, investment funds and others does not only provide opportunities for high rewards. Investing your money also entails the risk of losing part of or, in the worst case, all of the capital you have invested. 

This means that knowing about risks and their consequences should be part of your “knowledge toolkit” before you start investing. You should recall potential risks before any investment decision you take. Which risks could adversely affect the performance of your investment?

Your behaviour as an investor

This is an obvious and important risk. Even if you are using a financial services provider such as a broker or a bank, investing your money means that, first and foremost, you are responsible for your investment. You need to do something called “due diligence” before investing in a financial product. 

Even if you are using a financial services provider such as a broker or a bank, investing your money means that, first and foremost, you are responsible for your investment. 

Due diligence risks

In a nutshell, “due diligence” means that you need to carefully analyse and examine the financial, economic, legal and tax situation of a company if you are considering buying their stocks. Exercising  due diligence fundamentally applies to each financial product that you are considering as investment. This also means that you obtain all necessary information and observe any deadlines regarding your investment. 

Investment cost risks

Investing is not free. Financial institutions will charge fees for purchasing and managing your accounts, investment fund shares and various other services. Even if a financial product is performing well, it may take a long time until you make gains from an investment. Keep in mind that all costs need to be covered before you receive any earnings. So make sure that you research different offers to ensure you don’t pay too much in fees, based on your personal situation. 

Market risk

The fear of price fluctuations may be the one risk that keeps most would-be investors from actually investing. The prices for securities, commodities and investment fund shares are all affected by price fluctuations. These fluctuations depend on a vast range of factors, such as the supply and demand of the financial product, factors affecting surrounding market conditions, stock market conditions and many more. 

The prices for securities, commodities and investment fund shares are affected by price fluctuations.

“Volatility” shows the degree of risk linked to an investment. Usually, the more volatile an asset, the higher the risk for an investor. On the other hand, volatile securities, such as digital assets, are also often associated with higher-than-average returns. Learn about the volatility of investments you are considering and how comfortable you are with the risks involved. 

Economic development risks

Fluctuations within a business cycle are also going to affect the performance of investments. The problem is that some investors ignore this risk and invest at the "wrong" time or in an unfavourable economic cycle. In a worst-case scenario, economic risks may result in other risks affecting investors, such as default risks of companies.

 
 
 
 

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Risks from tax law changes

In the end, the decisive factor in choosing a financial product is the income it is going to generate. Don’t forget that your investment gains will be taxed. Consequently, you should always include the tax treatment of an investment in your cost calculations. Also, keep yourself informed about current tax legislation in your place of residence. Unfavourable tax developments over the term of an investment may pose regulatory risks that affect your gains. 

Psychological market risks may also affect price developments on a stock exchange. 

Stock market risks

A stock market crash is something that you as an individual can’t really take precautions against. Negative political, financial, global or national crisis scenarios usually directly affect stock markets and especially the performance of indices and investment funds in a systematic way. This means certain developments affect the functionality of the entire system involved. 

Psychological market risks may also affect price developments on a stock exchange. Opinions and rumours involving a company can result in significant price changes regardless of a company’s actual earning situation.

Now that you know the general risks associated with investing, it is time to start learning about more advanced financial products.

FURTHER READING 

BOOKS

  • Nicholson, Colin - Building Wealth in the Stock Market: A Proven Investment Plan for Finding the Best Stocks and Managing Risk

  • Lynch, Peter - One Up On Wall Street: How To Use What You Already Know To Make Money In The Market

LINKS 

Should you really do nothing amid market volatility?

Understanding investment risk

Low-risk vs. high-risk investments - what’s the difference?

This article does not constitute investment advice, nor is it an offer or invitation to purchase any digital assets.

This article is for general purposes of information only and no representation or warranty, either expressed or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, completeness or correctness of this article or opinions contained herein. 

Some statements contained in this article may be of future expectations that are based on our current views and assumptions and involve uncertainties that could cause actual results, performance or events which differ from those statements. 

None of the Bitpanda GmbH nor any of its affiliates, advisors or representatives shall have any liability whatsoever arising in connection with this article. 

Please note that an investment in digital assets carries risks in addition to the opportunities described above.