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Risks of Investing in Stocks Research Team | Posted On Tuesday, August 18,2015, 02:55 PM

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Risks of Investing in Stocks




Everybody loves the stock market. Great returns in no time. You invest INR 5,000 in stocks. What do you expect? You would settle for nothing less than INR 10,000 a couple of months later. All you care about are massive returns from the stock market. Doubling returns…Tripling returns…All this in no time at all.

But have you thought about the risks involved in an investment in stocks? Risk in a stock market means you could suffer massive losses if certain events do not go your way.


Risk comes from not knowing what you're doing.”     -   Warren Buffett


Market Risk


Certain factors beyond your control may affect the Indian or the World economy. This could lead to a crash in stock prices. Generally when the economy crashes, stock prices also crash.

Think…The Lehmann Collapse in 2008. A crash no one could have predicted.

Your stock portfolio will be in huge losses. You need to consider the unforeseen when you invest in stocks.


Investment by Foreign Institutional Investors

Yes… Foreign Institutional Investors (FII’s), invest heavily in the Indian stock markets. In fact they are the largest investors in the Indian stock markets.

FII’s are quick to invest in the stock markets and also quick to exit from them. When they invest heavily in the Indian stock markets, stock prices rise. Yes… Foreign Institutional Investors artificially inflate stock prices. You gain massive profits.

However FII’s can be fickle minded. Just as they have the power to inflate the stock markets, they have the power to deflate the stock markets.

If FII’s have better opportunities back in their home countries, they will exit Indian stock markets and shift their money back home.

Stock prices will fall and you will suffer massive losses.

See Also: Stock Exchanges In India


Inflation and Stocks


The rise in prices of goods and services with time, is called inflation. If inflation is high in the economy, the Government takes measures to bring inflation under control.

This is usually done by hiking interest rates in the economy. Investors shift their money from stocks to debt (fixed income), hoping to profit from higher interest rates. This causes stock prices to fall.

Consequently if inflation falls drastically, there is an interest rate cut in the economy. This would cause interest rate sensitive stocks such as automobiles, infrastructure and even banking and housing finance stock prices to rise.


Football Teaches Valuable Investment Lessons


You must have played a lot of football in your younger days. Now you spend time watching football on TV. Which club do you support? Is it Liverpool or Arsenal?

To win a football match, your team has to put the ball into the opposition’s net and score more goals than the opposition.

To win a football game, your team needs to have a strong defense (set of defenders and a good goal keeper), as well as a strong set of attackers (players who score goals called strikers).

The job of the defenders is to make sure; the opposition does not score a goal against your team. A good set of defenders and the goal keeper, makes sure that no goals go into your net.

Your strikers score goals and help your team win the match. If your team scores more goals than the opposite team, your team wins the match.

Just as in investing, football carries risk. The risk is that the opposition, could score a goal and you fall behind in the match. Your team could also score a goal and win the match. This is similar to return in an investment.


Offensive and Defensive Stocks


You must have heard the word “stock portfolio”. This is investing in stocks of different Companies to give you diversification benefits.

When prices of certain stocks you hold in your portfolio fall, prices of other stocks in the portfolio might rise. This has a balancing effect on your portfolio called diversification.

Just as football has attackers and defenders, your stock portfolio must have offensive and defensive stocks.

Stocks of IT firms, FMCG and Pharmaceutical Companies are generally called defensive stocks. Their prices tend to rise when the stock markets crash, or at least do not lose much value.

These stocks are very handy to have in a bear market. They are similar to the defenders and the goal keeper of a football team, who just do not allow the opposition to score.

Stocks of automobile Companies, Infrastructure and cement are called offensive stocks. Their prices rise rapidly in a booming market. In a bull market these are the stocks to have.

They are similar to the attackers of a football team, who score goals and win the match.

Your stock portfolio must have both offensive and defensive stocks. This means you gain both in a bull or a bear market.

Remember: Stock market may give you a great return, but also carries great risks. So invest smartly in stocks and make a profit.


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