Lesson 11 of 43: What Are the Risks of Investing in Stocks?

  • We cover a range of investing risks, including company, industry, market, and investor-level risks. 
  • Truly understanding each risk allows you to develop a strategy to protect against it. 
  • We don’t intend to scare you away from investing. Remember, since 1926, the S&P 500 has never had a 15-year period where it failed to deliver a profit.

Everything in life comes with risk, and stocks are no different.

If you want something that’s truly risk-free, U.S. treasury bills are often considered to be the lowest risk investment in the world.

The only problem is they are a terrible long-term investment. This chart from Morningstar shows how horribly treasury bills have performed compared to stocks since 1926.

The good news is a lot of the risk in the market can be reduced by following well-researched practices and avoiding common mistakes.

Today, we’ll outline some common risks and in future lessons we’ll discuss how to reduce your exposure to them in your own investing.

To be clear, this isn’t an exhaustive list of all the possible stock market risks.

And the purpose of this lesson isn’t to scare you away from investing.

We want to help you understand the common risks so you can develop an investing strategy that balances risk against reward in a way that’s right for you.

Company-Level Stock Investing Risks

In this section, we’ll look at various risks that could impact a single company you’ve invested in.

These aren’t large market-level risks such as a stock market crash (we’ll cover that below), but risks that would mostly impact a single stock directly.

  • Negative Headlines: Investors know how much a negative news story can impact a stock’s price. True or false, fair or unjust, news headlines have the power to move stocks fast.
  • Analyst Downgrades: When an analyst downgrades a stock or lowers their financial forecast, the stock’s price often follows close behind. While analysts aren’t always right, their opinions do tend to move markets in the short term.
  • Credit Risks: If a stock is running out of cash, needs to issue more debt, or is struggling to pay its existing debt, the stock is likely to suffer.
  • Strong Competitors: Strong competitors (or disruptive new entrants to a market) can steal business from a company, causing their sales to decline and their stock price to fall.
  • Bad Leadership: Poor decisions from company executives can steer a company down the wrong path and hurt the stock price. Similarly, departures of valuable leaders (especially suddenly or as a result of scandal) can leave a company rudderless and the stock headed down.
  • Legal Troubles: Companies can suffer legal troubles for many reasons, such as fraudulent reporting, illegal activities, inaccurate advertising, regulatory violations, and more. While nearly all large companies have some type of legal battle happening at any given time, a big and unexpected legal problem can hurt the company’s stock price.
  • Accidents: If a company is somehow responsible for causing an accident (for example, BP’s Deepwater Horizon oil spill in 2010), it can mean a dark cloud forms over the stock as investors anticipate the fallout from regulators, customers, governments, and more.
  • Dividend Cuts: High dividend stocks that cut their dividend tend to be punished by Wall Street. This is especially true if they had a high dividend yield or a reputation as a good dividend stock.
  • Bankruptcy: While not terribly common (especially among mid cap stocks and large cap stocks), there’s always a risk a company can declare bankruptcy which could make its shares nearly worthless.
  • Low Liquidity: If there aren’t enough buyers or sellers for shares of a certain company, it can be hard to trade. This means investors who currently own the stock could be forced to choose between holding it or selling it for much less than they’d like.

Industry-Level Stock Investing Risks

Industry-level risks are things that can occur to entire industries (or even sectors). While they may affect stocks outside the industry, their primary impact is on stocks within the industry.

  • Restrictive Legislation: Governments can pass legislation that fundamentally changes the way businesses in a certain industry operate or somehow drives up their costs and/or down their sales. While there may be good reasons behind such legislation, it can still hurt many of the stocks within the industry.
  • Trade Wars: When countries are locked in trade wars, they often use tariffs to damage key industries in each other’s economy. For example, China has recently threatened tariffs on U.S. aircraft which would surely harm Boeing (BA) and many other airline manufacturing stocks.
  • Currency Changes: If a country’s currency were to change dramatically, it could hurt many stocks in an industry if they all rely on sales or supplies from that country.
  • Challenges in Related Industries: Sometimes challenges in one industry can spread and impact other industries. This is especially true when one industry is a supplier and the other industry is their customer. For example, if semiconductor companies ran out of critical supplies, consumer device companies like Apple (AAPL) would likely suffer.
  • Rising Commodity Costs: If an entire industry relies heavily on a certain commodity, dramatic increases in its price could hurt their margins. For example, airlines such as United Continental (UAL) might suffer if the cost of their fuel spiked for some reason.
  • Interest Rate Increases: Interest rates are bound to increase (and decrease) as markets go through business cycles. However, sectors which rely heavily on borrowing money to grow, such as Real Estate, can suffer more than others when interest rates are rising.

Market-Level Stock Investing Risks

Looking beyond just risks to a specific stock or related stocks within an industry, we have risks that can impact the entire stock market:

  • Stock Market Crashes: A collapse in the stock market (which can be due to many different reasons) tends to spare very few companies. Often sell-offs are based on panic and emotion, and healthy companies are punished right along with troubled companies.
  • Social / Geopolitical / Black Swan Events: Unexpected high-impact events such as wars, terrorist attacks, social uprisings, and natural disasters can turn the stock market upside down overnight. Depending on the severity and lasting power of the event, markets recover at different speeds.
  • Economic Recession: An economic recession, which can be driven by many different causes, can damage stocks by hurting their growth and dampening investor sentiment.
  • Inflation / Deflation: Both inflation and deflation can be destabilizing to stocks and entire economies. This is especially true if the rates of inflation / deflation are aggressive enough to undermine confidence in the currency.
  • Interest Rates: If a government were to raise interest rates too quickly, it could have a depressing effect on the economy, which will likely hurt the stock market.
  • Taxes: Dramatic changes in tax policy could slow consumer and corporate spending, dampen sentiment, and cause the stock market to decline.
  • Removal of Fiscal Stimulus: If a government has been spending heavily to stimulate the economy and then suddenly they decide to stop, it can cause a shock to the markets.

Investor-Level Stock Investing Risks

Finally, on top of all the company, industry, and market-level risks we face, there’s one more big risk – the investor.

There are many common mistakes that investors make and we’ll outline them all (and how to avoid them) in a future lesson. But for now, here are a few simple examples:

  • Unlucky Timing: Through no fault of your own, if you were to put all your money into the market at once you could suffer from unlucky timing. Maybe that was the market peak and stocks sell off for the next few years.
  • Not Being Diversified: Being too concentrated in your investments is a big source of risk. Investors sometimes hold too few stocks in their portfolio or concentrate all their stocks in a single industry. Both are big risks.
  • Not Investing At All: Investors who are afraid to lose money sometimes put their money into ultra-conservative, but poor performing investments such as bonds or even worse, cash. Over long periods of time, they miss out on a ton of potential wealth because they’re afraid of the stock market crash “bogeyman.”
  • Timing the Market: Investors try (unsuccessfully) to time the market, jumping out right before market declines and jumping in right before market recoveries. Research shows this is very difficult to do well and very costly to most investors.

Again, this is just a brief sample of common investor mistakes. We’ll cover the full list (and what to do instead) in an upcoming lesson: Lesson 36 of 43: The 23 Biggest Mistakes Investors Make (And How to Avoid Them

Stock Market Investing Risks: Lesson Summary

When it comes to investing in the market, there are risks at all levels. Bad things can happen to the entire global economy, certain sectors and industries, the specific companies you buy, or even just to your personal portfolio.

Again, we don’t intend to scare you away from investing. Remember that since 1926, the S&P 500 has never had a 15-year period where it failed to deliver a profit.

But the better you understand these risks, the better equipped you’ll be to avoid them when investing your money in the market.

Now that you understand the risks of investing in stocks, let’s step back and look at some of the common myths that come along with stock market investing.

We’re sure you’ve heard most of these before. And you may be surprised by what’s true and what’s not. Find out in Lesson 12: 18 Stock Market Investing Myths Debunked

Loading
Author

Todd Lincoln

Author

Passionate stock market investor with deep experience trading small cap, dividend, and growth stocks.

Want our best stock picks, market insights, recession alerts, and investing education delivered to your inbox?
Loading