What are risks of investing in stock market?

Investing in stocks involves a number of risks. Among all, few of them can be controlled by the investors. However, for the remaining, there’s not much that the stock market investor can do.

Nevertheless, if you know the risk, the chances are that you can mitigate it or at least can have a back plan.

Here are a few top risks involved while investing in the stock market:

Market risk

An investor may experience losses due to factors affecting the overall performance of financial markets. Stock market bubbles and crashes are good examples of heightened market risk. You can’t eliminate market risk, also called systematic risk, through diversification. You can, however, hedge against market risk.

Even though systematic risk affects the entire stock market, the extent to which the market feels the impact can be minimized. Dividend exchange-traded funds such as the iShares Select Dividend or the Vanguard High Dividend Yield ETF can be valuable in this regard.

Inflation risk

Inflation risk also called purchasing power risk, is the chance that the cash flowing from an investment today won’t be worth as much in the future. Changes in purchasing power due to inflation may cause inflation risk. Some ETFs, including the iShares Barclays Treasury Inflation-Protected Securities Fund (TIP), invest in U.S. Treasury inflation-protected securities to minimize inflation risk.

Liquidity risk

Liquidity risk arises when an investment can’t be bought or sold quickly enough to prevent or minimize a loss. You can minimize this risk to a good extent by diversifying. A good option is an index investing where risk is diversified over the various stocks held in a portfolio tracking a particular index. ETFs such as the SPDR S&P 500 ETF (SPY) and the Vanguard Total Stock Market ETF (VTI) offer this benefit. They invest heavily in stable large-cap U.S. companies like Apple (AAPL) and ExxonMobil (XOM), and so have minimal liquidity risk associated with them.

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 you should only invest money that you don’t need to pay bills or other day-to-day responsibilities. You should set a goal and try to invest in medium/long term on at least some companies. Don’t put all eggs in one basket.

If you miscalculate your time setting, then you may be facing the market risk, the risk of having to sell your shares right when the market is shrinking (called a bear market).

If you miscalculate your position (spend everything on a single company with small capitalization, what means few shares being traded at once) you may be facing liquidity risk, the risking of need to sell and cannot do it be quickly enough or without impacting the price or even at all (no one willing to buy).

If you pick bad companies you may be facing equity risk, that your portfolio underperforms, so to shares won’t raise as much as the rest of the market or maybe even lose value.

If you leverage (spend borrowed money) you may be facing margining risk, that is your future cash flow may be smaller than expected and you won’t have money to cover the margin call, so you will be forced out of the market. All three above are species of market risk.