Investing in stocks is risky because when you do, you could lose all of your money, in some cases, more than you invested. There are some risks you have some control over and others that you can only guard against. Also, thoughtful investment selections that meet your goals and risk profile keep individual stock and bond risks at an acceptable level.
Thus, before you buy a stock, understand the risks and decide if they are risks you can take. In this article, we will continue to look at some risk that every stock faces, regardless of its business.
Just in case you have missed the first part of this article, you can find it here: Risks in Stock Investment (Part 1)
Legislative risk refers to the complicated and faltering relationship between government and business. Specifically, it’s the risk that government actions will force a corporation or industry. The actual risk can be realized in a number of ways: an antitrust suit, new regulations or standards, specific taxes and so on. The legislative risk varies in degree according to industry, but every industry has some.
Interest Rate Risk
Interest rate risk, in this context, simply refers to the problems that a rising interest rate causes for businesses that need financing. As their costs rise due to interest rates, it’s harder for them to stay in business. If this climb in rates is occurring in a time of inflation, and rising rates are a common way to fight inflation, then a company could potentially see its financing costs climb as the value of the dollars it’s bringing in decreases.
Inflation risk hurts investors on fixed incomes the most since it wears away the value of their income stream. Stocks are the best protection against inflation since companies can adjust prices to the rate of inflation. Although the “rates occurring in a time of inflation” double trap is less of an issue for companies that can pass higher costs forward, inflation also has a dampening effect on the consumer. A rise in interest rates and inflation combined with a weak consumer can lead to a weaker economy, and, in some cases, stagflation.
Model risk is the risk that the assumptions underlying economic and business models, within the economy, are wrong. When models get out of whack, the businesses that depend on those models being right get compromised. This starts a domino effect where those companies struggle or fail, and, in turn, hurt the companies depending on them and so on.
There is no such thing as a risk-free stock or business. Although every stock faces these universal risks and additional risks specific to their business, the rewards of investing can still far offset them. As an investor, the best thing you can do is to know the risks before you buy in.
Read about How to Invest in Stocks Without Too Much Risk.
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