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Hidden Investment Risks!
Posted On September 27, 2010
Hidden Investment Risks!
Financial education plays an important role in my life. Ever since I have realized that it is important to make money work harder for me, I have been constantly reading and learning about financial education. With the new knowledge that I have gained each day, I have realized that I am improving in my ability to identify risks in an investment.
Identify risks is the first step to evaluate an investment. If I want to be a sophisticated investor as defined in the Rich Dad’s series by Robert Kiyosaki, then I definitely need to be able to identify risks in an investment. If I do not know what are the risks involved, I will not be able to manage the risks. If I cannot manage the risks, then I will have a high chance of losing money in the investment. That is something that I want to avoid. If I had foolishly invested without the knowledge of the inherent risks in the investment, then I would be considered to be a gambler than an investor.
Every investment has risks that are obvious and risks that are hidden. Someone with a little knowledge can easily detect the obvious risks. But for the hidden risks, it takes someone who is experienced in that field to see.
Take stock investment as an example, what are the obvious risks and hidden risks involved?
The first obvious risk is the risk of losing money. If I have invested in a stock and the share price drops, then I will be losing money.
The second obvious risk is that a company can go bankrupt. When a company go bankrupt, the shares of the company become worthless.
The third obvious risk is that a company may de-list from the stock exchange. When a company de-list from the stock exchange, the shares become worthless.
What about the hidden risks?
Firstly, there is a risk of addiction in stock investment. This will cloud my judgment in selecting stocks to invest. Where does the addiction come about? When the share price goes up, I feel excited because I am making money. The effect of excitement is like drinking liquor to feel high. When the share price goes down, I feel depressed because I am losing money. The effect of depression is like taking alcohol to feel low. This up and down of emotions is a source of addiction. In fact, this risk exists in investments such as options, currencies and commodities.
Secondly, there is a risk of falling in love with a stock. Again, this will impair my judgment in selecting stocks to invest. How do I fall in love with a stock? Well, all I need to do is to make money from a particular stock a few times. Thus, I have attached a positive experience of making money by investing in that stock. When I am selecting stocks to invest, I will have tendency to select that stock again even though the technical analysis or fundamental analysis says otherwise.
Thirdly, there is a risk of the government changing the policy thus affecting the stock market. If a government changes the policy that impacts investment negatively, foreign investors may withdraw their funds from the stock market. This will result in the stock market crashing. In other words, I will lose money in my stock investment.
Next, there is a risk of external events that will affect the stock market. For instance, a terrorist attack will affect the stock market because the confidence of investors is shaken. Similarly, a great natural disaster will affect the stock market.
Then, there is currency exchange rate risk. This is true if I have invested in stock that is listed in foreign currency in a local stock exchange. Another possibility is that I have invested in a stock listed in a foreign stock exchange. If the share price increases, then I should be making money. But if the foreign currency depreciates in value against the local currency, then I may end up losing money.
Lastly, there is a risk of leverage. Before I am allowed to trade in a stock market, I will need to have a brokerage account with some money. Usually, the brokerage firm will allow me to leverage by trading up to several times the amount of money in my brokerage account. Sometime, the brokerage firm provides margin account for trading to enhance leveraging.
Leveraging is a two edged sword. It can work both ways. If the share price goes up, I can make more money by leveraging. If share price goes down, I will end up with a lot more money to pay because of leveraging. Leveraging is like a magnifying glass that will magnify my trading mistake.
The list of hidden risks may not be incomplete since I am still learning about stock investment. The main point that I want to raise is that financial literacy is important as highlighted in the Rich Dad’s series by Robert Kiyosaki. I have simply used stock investment to illustrate my point.
* DISCLAIMER *
The author only provides the material and information as a layperson’s views about an important subject. The materials and information are from sources believed to be reliable and from his own personal experience, but he neither implies nor intends any guarantee of accuracy.
All the materials, information and procedure in this book are only the author’s personal opinion. You must consult your own professional advisor and other reputable sources on any matter that concerns you or others.
The author, publishers and distributors are not competent and do not profess to give legal, accounting, medical or any other type of professional advice. The reader must always seek those services from competent professionals who can review your own particular circumstances.
The author, publisher and distributors particularly disclaim any liability, loss, or risk taken by individuals who directly or indirectly act on the information contained herein. All readers must accept full responsibility for their use of this material.
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