Investing in Riskier Assets
In the investment world, the terms “high-risk” and “low-risk” are often applied to different types of assets. In investment terms, risk can be defined as underperformance and loss of capital relative to how you expect the investment to perform.
A low-risk or “safe” investment, such as savings accounts and government bonds, carries a low level of liability for the investor. Because of their low level of associated risk, such investments are generally associated with low potential gains.
On the other hand, high-risk or risky investments typically include assets with a greater degree of price volatility, such as stocks, currencies, real estate and high-yield bonds. Risky investments are generally associated with higher returns but are also potential for higher losses.
Is it a good idea to invest in riskier securities? The answer may depend on your investment goals, timeframe and individual circumstances. To pursue the high returns associated with risky assets, you must understand their risks and be ready to shoulder potential losses.
The guide below introduces the concept of riskier investments and explores some of the riskiest assets available for today’s investor.
What is the risk-return tradeoff?
To understand the idea behind investing in riskier stocks, the risk-return tradeoff theory is a good place to start. The risk-return tradeoff is the principle that greater perceived risks come with higher expected returns, while smaller perceived risks are accompanied by lower expected returns. Applying this theory to investing, your money may see higher gains if you embrace the possibility for greater losses.
To make investment decisions and develop their portfolio, investors use the risk-return concept. Different investors have different tolerances for the risks they are willing to take with their money. Some investors may include high-risk investments in their portfolio in pursuit of greater gains. Others may stick to safer investments in order to minimize the potential to lose capital. Factors that influence an investor’s tolerance for risk may include age, income and financial goals.
10 of the Riskiest Types of Investments
Some of the riskiest assets may come with the possibility to double your initial investment in a short period. Learn about 10 of the riskiest assets you can invest in below.
- Initial public offerings. Initial public offerings (IPOs) are a company’s first offering of stock to the general public. Investing in IPOs can be risky because there is no data demonstrating how well the new company is likely to perform. On the other hand, this type of investment can also lead to high returns, offering investors the opportunity to buy in when shares are underpriced.
- Venture capital. Venture capital is funding provided to small companies and startups that are in seed, early and growth stages. As with IPOs, venture capital can be risky because of the high degree of instability of startup companies but carry the potential for huge gains if the company is successful.
- Promissory note. With promissory notes, sometimes referred to as “corporate notes,” a private company makes a promise to the lender to repay borrowed funds with interest within a certain timeframe. Investing in a private company is risky because there is no assurance that the early-stage company will make enough money to repay the debt. Although there are legitimate promissory notes, this type of investment is sometimes used to defraud investors.
- Stock options. Stock options are a financial instrument that gives the holder the right to purchase or sell stocks at a certain price at a future date. Options are a risky type of investment because they restrict the buying and selling of stocks with time limits. The price of stock options rises and falls quickly and unpredictably, and investors have the potential to gain or lose large amounts of money in very brief periods.
- Foreign emerging markets. Investing in a foreign country that is witnessing economic growth can be a lucrative but chancy investment. This type of investment can be high risk because of the potential that the period of growth may come to an unexpected and sudden end.
- Investing in foreign currency. Currency trading, sometimes called forex market trading, is the exchange of one country’s currency for another. Because currency rates fluctuate quickly and constantly, currency trading is considered a high-risk investment.
- High-yield bonds. High-yield bonds, sometimes called “junk bonds,” are corporate bonds with a low-credit rating. Although government bonds and high-grade corporate bonds are typically considered safe investments, high-yield bonds are a high-risk investment because they carry a higher likelihood of default. Consequently, high-yield bonds pay a higher coupon payment and come with a greater potential for price appreciation than other kinds.
- Penny stocks. Penny stocks are shares of a company offered at less than a dollar each. Although purchasing these types of ultra-low shares from the right company may result in major gains, penny stocks are typically associated with volatility and large losses.
- REITs. Real estate investment trusts (REITs) are companies that invest in collections of commercial or residential income-producing properties. REITs provide investors with high dividends but may fluctuate widely in value according to changes in the current economy and real estate market.
- Alternative investments. Alternative investments may include hedge funds, gold and precious metals, collectibles and oil and gas leases. Such investments may deliver high returns to the well-informed, strategic investor, but they could also plummet in price and become basically worthless.
Should you invest in high-risk investments?
When it comes to investing, risk is not necessarily a bad thing. A high-risk asset comes with the potential for dramatic returns. The key to investing in high-risk securities is to choose the right risk, which requires a superior degree of expertise, research, dedication and risk management efforts.
Ultimately, there is no one-size-fits-all answer to how much risk you should take on when investing. Before making any kind of investment, take a close look at your income, age and investment goals to assess your risk tolerance. Once you have determined how much risk you are willing to absorb, you can make investments based on your personal tolerance.