Money Management
November 11, 2024
If you have been investing for a while now, you are aware of the risk/reward trade-off concept. It is simple – the greater risks you take, the greater your reward if your investment makes money. Investors who take high risks are generously rewarded because they stand to lose the most.
High-risk investments have a comparatively high chance of causing devastating loss. If you invest in them, there is a high possibility that you might lose initial capital or the investment will underperform. High-risk investments are often volatile but promise high returns to attract individuals with a high-risk tolerance.
Individuals with high-risk tolerance are aggressive investors who are willing to take the risk of losing more to get potentially better returns on their investments. They can stomach losses, withstand long market volatility, favour capital appreciation over income generation, and often invest in long-term goals. They're also younger, in their 30s or early 40s, and have high-risk capacity.
So, what investments can you put your money in if you have a high-risk tolerance? This article will explore some of those scary instruments, capture the risks involved and close up with what you can do to protect yourself when investing in them. Read on.
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High-risk investments promise high returns, but before you put your money in them, remember that there are no guarantees. The returns you receive might be below the promised ones, and you also stand a chance to lose some or all of your initial investment. These investments can also be volatile and illiquid.
Here are some examples of high risks investment vehicles you can explore
When you buy stocks or shares of a company, you are essentially purchasing a piece of the company. And that means you are tying your money to that specific company. If they perform well, you will receive returns on your investment, and if they don't, the value of your investment drops. This type of investment promises capital appreciation and sometimes dividends, but it is all subject to market performance.
When a company you invested in is hit by market risks or underperforms, the value of your stock will plummet, and if the company doesn't generate profits, you won't receive dividends. If the company goes bankrupt, your stocks will become worthless, causing you to lose 100% of your investment.
Stocks are liquid investments; you can buy and sell stock and shares of publicly traded companies on the stock market. You, however, run the risk of selling at a loss if markers are down when you want to liquidate. Always factor in your investment time horizon and be ready to extend it to avoid these risks.
To mitigate risks, you should diversify your stock portfolio across different companies and industries. This way, you minimise loss when one company's shares are down. You can use the profits from another to cancel it out when rebalancing your portfolio.
The returns can also be very high depending on how the stock performs. It may especially pay off if you are investing with a long-term view as opposed to expecting a windfall in the short-term which while still possible, may be a little of an unrealistic expectation.
Investing and diversifying your portfolio across high risks instruments can be tricky, especially when you have little investing knowledge or low-risk capacity. This is where mutual funds and their equivalents can work to your advantage. These professionally managed funds pool money from various investors and invest it in medium to high-risk instruments.
An example of such investments are:
Equity Funds: These invest in publicly traded companies on the NSE. They are regulated by the CMA and promise investors long-term capital gains. But since they invest in shares, returns are subject to market performance.
Mutual funds are a type of unit trust fund; you can withdraw your money anytime. But the amount can be lower than what you invested depending on the prevailing market state when you make the withdrawal.
You can invest in equity funds through financial institutions such as banks and leading insurance providers in Kenya.
REITs - This type of investment pools funds from various investors and invests in real estate. The returns generated are divided amongst pool members and paid as dividends.
You can invest in non-traded and publicly traded REITs in the NSE. While they promise steady income and capital appreciation, REITs are vulnerable to market risks like interest rates which might affect your returns.
REITs haven't been widely adopted, exposing you to liquidity risks as selling your stake can prove to be relatively hard, especially if you are holding non-traded REITs.
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Commercial Papers are unsecured debt instruments offered by companies looking to raise short-term funds. Investing in commercial papers is loaning a corporation money on the promise that they'll pay at the end of the agreed period. Commercial papers are also known as promissory notes.
Commercial Papers are high-yielding investments that can earn you money in two ways. They can pay monthly compounded interest over its period, which is generally higher than the prevailing market rates. And you can also buy promissory notes at a discount and receive the face value on maturity.
You face default and liquidity risks when investing in commercial papers. Since the loan you are giving the company is unsecured, you have little recourse when they default. You might be forced to count your losses. Additionally, reselling your commercial notes might be challenging, and you might be forced to hold them until maturity, even when you need access to your money before them.
To minimise risks while investing in commercial papers, it is advisable to buy them from companies with a solid track of meeting their debt obligations.
Corporate Bonds are long-term debt instruments you can invest in to earn attractive interest. They work in the same manner as commercial papers, with the main difference being the investment period. Corporate bonds tend to have a longer maturity period of more than one year.
Companies float corporate bonds when looking to fund long-term investment goals like expansion, growth, and acquisitions. This type of bond generally earns investors interest that is paid at agreed intervals like monthly, quarterly, or annually. The principal is returned on the maturity of the bond.
The biggest risks associated with investing in corporate bonds are:
When investing in these instruments, always ensure the company is established, has a history of keeping promises, and will use the money you loan them in ways that lower risk exposure.
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Derivatives are financial contracts and options that derive value from other assets like stocks, currencies, commodities, indices, etc. Investing in the derivatives market involves betting on the future value of an investment. When done correctly, it allows you to take advantage of market fluctuations to make a profit.
When you make a derivative trade, you promise to buy or sell an asset at a future price different from the current market price. If the price changes, you stand to make a profit or loss depending on the prediction you made.
For example, if the stock price of company X is trading at Ksh30 per share, you can promise a fellow derivatives trader you will buy the share from them for Ksh33 in five months. You will be betting that in that period, the price will be above Ksh33, and you can buy and resell immediately and pocket the profit. The other trader will be obligated to sell to you as you'll be compelled to buy at that price even if the shares tank to Ksh25 in the same period.
The risks you face when involved in this trading are counterparty risks - one person not keeping their promise and the unforeseeable market risks that can work against you.
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Cryptocurrencies are highly volatile digital currencies that rely on no central authority to uphold or maintain them. The currency is speculative and one of the most high-risk investments in the world. You can trade crypto or hold it for a period with the hope of selling it at a higher price in the future.
Holding cryptocurrencies can expose you to various risks. This includes hacking if you store your assets in a digital wallet, liquidity risks as you might be forced to sell at a loss when you urgently need money and the markets are down, and finally, counterparty risks when the creator of digital currency vanishes with all investors money or misuses it causing an irreversible loss.
Their value can also be affected by forks - this happens when there's a protocol change and a blockchain diverges into two or more paths forward.
Always do enough research before investing in any cryptocurrencies and store your crypto in a safe place that makes you less susceptible to hacking.
Read Also: Investment and Risk-Taking Lessons from The Crypto Crisis
Know your limits - When investing in high risk, you must not exaggerate your risk capacity and tolerance. Only expose yourself to risks you can comfortably bounce back from if they backfire. This will ensure you don't put yourself in a financial position that could be detrimental to your future.
Diversify and Rebalance Constantly - High-risk investments are volatile with high fluctuations. This means you don't only need to ensure you are diversified enough but also to keep an eye on your assets and rebalance your portfolio often. This will ensure you can avoid long-term losses and eliminate investments slowing down your financial growth.
Maintain Liquidity - As you invest in high-risk vehicles, you'll notice that they can easily be liquidated. However, depending on market prices, you might be in an unfavourable position if you liquidate when markets are down.
Exiting at this stage can cause you losses. To avoid this, keep safe liquid investments that can help you deal with emergencies and take advantage of opportunities when they arise.
Read Also: 6 Consequences of Not Having an Emergency Fund
Don't Invest Blindly - Just because an investment promises a return doesn't mean returns are guaranteed. Always do independent research and talk to experts before investing in instruments you do not know about.
Read Also: Too Good to be True? Signs It’s a Get-Rich-Quick Scheme, Scam
High-risk investments might sound exciting, especially when you are still relatively young and approaching your prime earning years. But before you dive in, you should know that this type of aggressiveness is unsuitable for beginners. Therefore, first invest in learning before you start taking risks. This can be by taking a financial literacy class or talking to an advisor.
You should also consider taking it slow, starting with one risky investment, mastering it, and moving to the next. Keeping your ‘greed’ level in check as you invest is also important - it can help you avoid emotional investing and taking more risks than you can handle.
Finally, learn to differentiate high-risk investments from scams. When the deal is too good to be true…
Scammers often sell their scams as high-return investments with little to no risk, and falling for this means losses for you. Always ask for licences and registration forms from regulatory bodies and verify them before you invest in any company selling investment products.
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