The stock market as an investment avenue is risky compared to other types of investment. However, the risk can be managed and mitigated but it is not as safe as a bank fixed deposit.
The stock market has proved overtimes that it will give or outperform almost all the investment avenues (Gold, Bank deposit, Real estate, and so on), A well-planned investment can be a great way to build wealth and also fulfill the goals and achieve financial freedom.
Now let us understand the risks associated while investing in the stock market.
The price of a stock is determined by the demand and supply of the stock in the share market. Hence, it fluctuates every day and within the day too.
As an investor buy stocks he is entitled to dividends or by the appreciation of the price of the stock over time, there is a risk of price depreciation as well, this is referred to as market risk.
A share is a part of ownership in the company, if the company faces a problem in the business, then the price of the company falls, this can b referred to as a company risk.
Before investing an investor should refer to the financial statements and also about the management, this can mitigate the company loss.
Dividends fetch regular income in stocks, However, a company with liquidity problems can withhold dividends and also can find it difficult to manage its working capital or to repay the debts.
This liquidity crunch will not fetch any dividends, this will further adversely affect the stock price.
The government keeps changing tax rules based on the needs of the economy.
If the sector that you have invested in, gets adversely affected by any such tax laws, then the stock price can fall within no time.
Many sectors are governed by regulatory bodies. For example pharmaceuticals, tobacco, telecommunication, Banking, Mining, etc. Any change made by the regulator or government can impact the business of all companies in the sectors causing a fall in the market price of the stock.
Inflation is an increase in the price of commodities and products in a given period. When the inflation rate increases, companies have to spend more to procure the same amount of raw material.
A sudden rise in inflation rates can impact the profitability of companies causing a fall in the market price of the stock.
Many experts and rating agencies analyze the company stock and performance and give their respective ratings based on the analysis.
This will have a direct impact on the stock movement. The rating can be either negative or positive, it can often swing the shares to some extent.
Emotional decisions towards a particular stock can be a mistake in investing in the stock market.
Most of the time emotions like greed and fear will impact negatively the portfolio and can end up in loss.
Monetary policy Risk:
The central bank changes the interest rates on deposits and loans based on the direction in which the economy is headed.
Hence, if the interest rates increase, companies get loans at higher rates that can cut into their profits and affect the stock price.
On the other hand, if interest rates fall too low, then it is an indication of a slowdown in the economy, and businesses suffer losses too. Hence, a balanced interest rate regime is healthy for the stock markets.
Closing Thoughts: There are various risks involved in the stock market, however, they can be controlled and necessary steps can be taken once you understand the risk. Long-term investment will reduce the risk as we are not bothered about the short-term risk as most of the above-discussed risks are for the short-term.
Calculated risk-takers are rewarded in the stock market in the long run.