Risks inherent in equity investingThe risk factor in equity investments is appreciably higher than fixed income securities such as fixed deposits or National Saving Certificates, or post office monthly income schemes.
04 Dec 2008
Like any avenue of investment (except those whose returns are guaranteed by the government, like the PPF), equity investing comes with risk. In fact, the risk factor in equity investments is appreciably higher than fixed income securities such as fixed deposits or National Saving Certificates (NSC), or post office monthly income schemes.
Company stocks are susceptible to risks, and these risks are carried forward to your investments as well. Here are a few:
- Business risks: The risks associated with the prosperity of a business and the demand for its products. There is always a risk that buyer profile or habits might change suddenly and a company's product goes from being the rage to an also-ran.
- Financial risks: The skill with which a company's finances are managed to ensure that it has an optimum level of debt, equity, reserves, etc. If a company's financials are ineptly handled, even in the short term, chances are that the ineptness will show up as a run on the stock in the future.
- Industry risk: Changes in technology, regulations, vogue, etc. can affect the performance of an industry sector as a whole, and a company stock of that sector might take the fall along with all its other competitors in that sector.
- Management risks: The level of corporate governance, management skills and vision determines the long term health of a company. Short term, ad hoc management decisions to ramp up profit sheets invariably leads to long-term grief for that company.
- Exchange rate risks: These factors affect a company but are outside its control, such as a sudden strengthening of the rupee that might affect exports, having adverse effect on an export-oriented company's stock.