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The Risks of Share Investing!

Posted:Abigail Andrews - Saturday, May 26th, 2007

Is Stock Market Investment Risky?

Over the long term all figures show that shares, on average, out perform many other forms of investment in terms of risk to return ratio. However, the stock market can go down as well as up! The crash of 1987 wiped millions off the stock market and lasted well into the millennium.

Like many other investments, stock market investment is more likely to perform better over the long term. Register for free with a site like ADVFN and take a look at a graph over a short period like 3 months then expand the range and look at it over 5 years and the trend will be quite obviously upward (see figure 1 below).

Figure 1
Source:ADVFN

Basically, in the long term, your investment is less susceptible to the volatility of the stock market, which is the larger differences between the highs and lows of stock prices. As long as you stick with it and you have a broad spread of companies, you stand to make money. The worst thing, and probably the most common thing, that investors do is panic and sell when their shares fall, only to see them keep on rising over the long term and those more wisely investors buy some bargains.

Making Money is Never Risk Free

If you want to make a killing in the stock market, you are going to have to take risks. If you keep all your life savings in safe investments such as a savings account, you will face virtually no risk and have some peace of mind, but your return will be low and inflation will make your initial deposit less valuable over time. There is a trade-off between risk and return. Less risk means less return, while taking on more risk brings the possibility of a higher return.

Are all Shares Equally Risky?

It's obvious really, the larger, well established companies with strong finances are much less risky than smaller or newer companies, where there is little history to base judgment on. The larger companies are less likely to go bust, but they too are not immune to rapid market fluctuations, however, they are safer investments. On the other hand they are unlikely to make you large profits as they are more unlikely to grow as quickly as the smaller companies. So it all depends on how much risk you are prepared to take for the potential reward.

The Risks of Investing

Inflation may eat away at your savings over the long term, but if share prices fall, you run the risk of losing money. If a company you invest in goes bankrupt, your shares could become worthless.

Furthermore, companies do not have to go under for you to lose money. Other investors may simply decide that the company is not worth as much as when you paid for it, perhaps because it is losing market share, and if enough of them think that, your investment will fall in value. Shares also tend to fall when the economy is deteriorating as investors recognise profits will be lower.

These are not, however, reasons for you to stay out of the stock market, but they should help you recognise the importance of building a broad portfolio with shares in different companies, industries and, even, countries. A good way for a beginner to do this is to invest in an Investment Fund, which spreads your money across 50-100 companies.

It is also worth noting that apart from those companies that go bust, shares that have fallen in value can recover in time. Sometimes if a share has fallen in value it can be worth holding on until it recovers, but at other times it may be better to cut your losses and invest in a company that has better prospects. The option you choose will depend on the company you are invested in and your individual circumstances.

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