What are the biggest risks in investing?

*Please note: The list of risks outlined in this article is not exhaustive and for informational 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.

As technological innovation is making investing more accessible to a larger audience, it is important for new investors to learn about the risks involved when investing money. 

Your individual financial situation, i.e. your income, your savings, your expenses, where you live, along with current market conditions, cultural influences and your investment goals, are some of the factors that make up your personal risk profile, which will help you do define your relationship with risk and return (your risk tolerance and your loss tolerance).

Understanding risk versus reward

It’s 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. Ask yourself: Which risks could adversely affect the performance of your investment?

One of them might be your own behavior as an investor. 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. This is why you need to do something called “due diligence” before investing in any financial product. 

What are 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 an investment. This also means that you obtain all necessary information and observe any deadlines regarding your investment. 

What are 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. 

What are market risks?

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. 

Volatility shows the degree of risk linked to an investment. Usually, the more volatile an asset, the higher the risk is 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. 

What are 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. 

What are the risks from tax law changes?

A decisive factor in choosing a financial product is the income it is going to generate - but 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. 

What are 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.