Risks of stocks
When you invest in a stock, you could lose all of your money – in some cases, more than you invested. Before you buy a stock, understand the risks and decide if they are risks you are comfortable taking.
2 key investment risks
- Returns are not guaranteed – While stocks have historically performed well over the long term, there’s no guarantee you’ll make money on a stock at any given point in time. Although a number of things can help you assess a stock, no one can predict exactly how a stock will perform in the future. There’s no guarantee prices will go up or that the company will pay dividends. Or that a company will even stay in business.
- You may lose money – Stock prices can change often and for many reasons. You have to be comfortable with the risk that you might lose all of your money when you buy and sell stocks, especially if you’re not planning to invest for the long term. If you use leverage to invest in stocks, like buying on margin or short selling, you could lose more than you invest.
A word about volatility
There are always ups and downs in the stock market. A stock price that changes quickly and by a lot is more “volatile”. This makes a stockStock An investment that gives you part ownership or shares in a company. Often provides voting rights in some business decisions.+ read full definition riskier – you could lose a lot if you had to get your money out on short notice.
It’s not enough to just look at a stock’s volatilityVolatility The rate at which the price of a security increases or decreases for a given set of returns. A stock price that changes quickly and by a lot is more volatile. Volatility can be measured using standard deviation and beta.+ read full definition from day to day. You should also look at the largest monthly or quarterly loss recorded. Volatility is measured in very precise ways:
- standard deviationStandard deviation A measure used to determine a stock’s volatility by measuring how widely its price has gone up and down in the past from its average price. More change results in a higher historic volatility.+ read full definition – measures how widely a stock’s price has gone up and down in the past from its average price. More change results in a higher historic volatility.
- betaBeta Measures how the stock is doing compared to overall stock market. A beta of 1.0 tells you that a stock has been going up and down with the overall stock market and is considered as volatile as the market. A stock with a beta between 0.0 and 1.0 has smaller ups and downs and may…+ read full definition – measures how the stock is doing compared to a given benchmarkBenchmark A yardstick that you can use to measure the performance of an investment. Example: a stock market index may be a benchmark you can use to compare how well your own stocks are doing.+ read full definition, such as the S&P TSX Composite Index. A beta of 1.0 tells you that a stock has been going up and down with the overall stock marketStock market The collection of markets and exchanges where stocks, bonds and other securities are issued or traded.+ read full definition. A stock with a beta between 0.0 and 1.0 has smaller ups and downs. A beta greater than 1.0 has wider price swings. Stocks with a negative beta are moving opposite to the indexIndex A benchmark or yardstick that lets you measure the performance of a stock market, part of a stock market or a single investment. Examples: S&P/TSX, S&P/TSX Canadian Bond Index.+ read full definition.
6 ways to manage risk
1. Hold a diversified stock portfolio
You may be able to reduce the ups and downs in the total value of your stock portfolioPortfolio All the different investments that an individual or organization holds. May include stocks, bonds and mutual funds.+ read full definition by buying stocks from companies with different features:
- Type of industry – While companies in one industry may struggle, companies in another industry may be doing well. For example, energy stocks might slump while technology stocks are rising.
- Company size – Investing in a smaller, newer company can offer the potential for higher growth, but it’s usually riskier than a larger, more stable company with a long history and good track record. You can reduce your overall risk by owning stock in companies of different sizes.
- Type of stock – Preferred shares tend to offer lower risk and returns than common shares. But they pay a fixed dividendDividend Part of a company’s profits that it pays to shareholders in proportion to the total number of shares held. The Board of Directors sets the amount. For common shares, the amount varies. It may skip dividends if business is poor or the directors invest money in things like new equipment or buildings.+ read full definition, unlike common shares. You may want to choose both for your portfolio. Learn more about common and preferred stock.
Before you decide on a stock or a portfolio of stocks, figure out how it fits with the rest of the investments you own, your overall financial goals and your tolerance for risk. Learn more about the risks of investing and how diversification can help reduce your overall risk.
2. Invest for the long term
The stock market is subject to short-termTerm The period of time that a contract covers. Also, the period of time that an investment pays a set rate of interest.+ read full definition fluctuations, as well as bear markets. But over the long term, the stock market has historically performed well. If you buy stock with money that you may need soon, you may be forced to sell in a period when a stock’s price is down. If you buy high and sell low, you’ll lose money.
3. Don’t try to time the market
Trying to time the market can be a risky strategy. You may hear about a stock that is climbing higher and higher in price. When more investors decide to jump in and buy the stock, they drive prices up even more. The price can fall just as fast, though, as investors start to sell to cash in on the big gains.
Other investors make the mistake of selling as soon as a stock price falls. But you don’t lose money on a stock until you sell it. If you hold on, the price may come back up. Stocks are long-term investments with many short-term fluctuations in price.
4. Get advice if you’re not a knowledgeable investor
It’s always risky to invest when you don’t understand how the stock market works, what makes a stock’s price rise or fall, or how an investment or investment strategy works. The more you know, the more you can lower this risk. If you don’t feel comfortable with your level of knowledge, a qualified advisor can help you choose stocks and other investments that meet your goals and tolerance for risk.
5. Be careful about buying private stock
Some companies keep their stock in private hands instead of trading their stock publicly on the stock market. The stock is owned by a group of shareholders who can only sell their stock with approval from other shareholders. The shareholders set the price at which the stock can change hands.
Buying private stock is risky because:
- You may not be able to buy or sell the stock when you want to.
- You may have to make a large investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition (unless you are an employee of the company).
- It may even be a scam.
6. Be aware of the dangers of investing offshore
Canada’s securities and banking laws protect you by offering recourse through the courts if you feel you have been harmed in your investing. When your money goes to another country, you may lose that protection. If you’re approached about investing offshore, be cautious – it could be a scamScam When someone tries to make money by misleading or tricking another person.+ read full definition.
If you don’t understand an investment and how it works, don’t buy it. The risks may not be worth it.
- Diversify your portfolio
- InvestInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition for the long term
- Don’t try to time the market
- Get advice if you’re not a knowledgeable investor