Many people are interested in starting to invest , but at the same time, the risks of investing are also frightening. However, investing allows you to multiply your invested wealth, but at the same time, losing your invested money is also lurking around the corner. The higher the return expectation, the greater the risk.
Do you know your own risk tolerance?
It is worth determining your own risk tolerance and making an investment plan. If this has not been done, there is a risk of ending up in a situation where your risk tolerance is not in balance. However, a downturn will come at some point, so it is worth preparing for it. Your own risk tolerance should be the basis for decisions about what proportion of each asset class you hold in your portfolio.
Risk tolerance involves both concrete and psychological risk tolerance and is linked to the financial situation. You can determine your own concrete risk tolerance by examining your income and expenses and the types of financial commitments you have.
Personal risk tolerance, on the other hand, determines how an investor should allocate long-term investment assets between stocks and fixed income investments. Poor investment success is often due to the choice of an investment strategy that is not suitable for one’s own risk tolerance. Many investors overestimate their risk tolerance when the stock market is performing well.
Risk is balanced by a long investment period and diversification
Diversification, or reducing risk by investing funds in many different assets, is based on the fact that the best and worst results of different investment assets occur at different times and in different economic cycles. Some assets have successes that offset the failures of others. In this case, the overall investment return is reasonably good.
Diversification should take into account different investment targets and their industries, geographical areas of operation and time. It is a good idea for an equity investor to own shares in at least five different companies, preferably ten. If an industry is in trouble and prices fall as a result, you will not get into trouble if you have diversified your investments into companies operating in different industries.
In time diversification, all the money is not invested at once, but regularly and little by little. This way, you don’t buy all the shares when the prices are high. By investing at regular intervals, you get more shares when the prices are at their lowest and correspondingly fewer when the prices are high. This way, the average price of your holdings becomes lower.
Time evens out investment risk. In the long term, share prices have historically risen. So if the investment period is long, the risk decreases. In this case, you can get a return on your shares with less risk.
What are the risks associated with investing in stocks?
Investing in the stock market always involves risks, as the value and return on investments can either rise or fall, and it is even possible for an investor to lose all of their invested capital. Historical returns and performance are no guarantee that returns will be made. Shares are highly volatile, meaning their prices fluctuate up and down. If you invest in shares for a very short term, you may have to sell your shares just as the price falls. Buying shares fits well into a long-term investor’s plan.
Risks associated with cryptocurrencies
You should never invest in anything you don’t understand. This rule also applies to cryptocurrencies. There are thousands of cryptocurrencies and it is impossible to know which ones will succeed and which ones will flop. However, the most well-known cryptocurrencies, such as Bitcoin and Ethereum, have established themselves.
If you invest in cryptocurrencies, it is good to note that they are traded around the clock every single day. This is why they are also excellent for trading. It is impossible to follow the prices of cryptocurrencies in real time. Their value can drop significantly overnight. Since investing in cryptocurrencies is associated with a high risk, it is a good idea to also diversify your investments into real estate, shares and ETF funds. This way you can protect yourself.
Diversification reduces risk
You shouldn’t put all your eggs in one basket, here’s the idea of diversification in a nutshell. When you diversify your investments, the risk is reduced. If one investment does not perform well, another one may perform really well, and this way the overall value of the portfolio remains good. A diversified investment is always less risky than an undiversified one. However, losses affect your finances more than profits, so diversification compensates for this risk.
Counterparty risk, i.e. the counterparty’s payment obligation
Counterparty risk is the risk that a counterparty will not meet its financial payment obligations. Some counterparty risk arises from any contractual payment obligation between at least two parties. Counterparty risk describes the payment obligation, not the risk arising from loan receivables.
Counterparty risk more generally describes the risk in the stock market, for example, when the seller of a derivative position has a payment obligation. Counterparty risk also arises in investments, where the counterparty does not deliver the securities it sells within the agreed time, even though payments have been made.
Operational risk
Operational risk is the consequence of an event that is caused, for example, by inadequate or ineffective internal processes of the portfolio manager. Operational risks are the risks of direct or indirect damage to the organization’s operations or damaging consequences for reputation that may result from errors or deficiencies in the organization’s internal processes. These may have a significant negative impact on the return of the fund unit.
Liquidity risks are assessed through monitoring
To ensure sufficient liquidity of the fund, the amount of liquid assets in the funds is monitored by the finance company. Various stress tests assessing liquidity risk also help in verifying liquidity. Redemptions may even be suspended in some situations or may take longer than normal.
Liability risks are covered by insurance
The fund manager is responsible for compensating for some damages, and for this purpose, financial companies have liability insurance required by law. This way, the investor is not left with nothing if the damage is specifically caused by the portfolio manager’s actions.
Fund investor and taxation
When an investor receives funds back from the fund, i.e. when he redeems fund units that have yielded positive returns or when a return is paid on A units, this results in tax consequences. Tax must be paid on capital gains from fund investments or on returns paid on the basis of return units. The capital gains tax is 30 percent up to 30,000 euros and 34 percent for the portion exceeding that.
Fund companies withhold this tax as a withholding tax when paying out the profit shares. It is up to the investor to check the accuracy of the capital gains on their tax return. The resulting loss can be deducted from the profits received. In the eyes of the tax authorities, investment books are also professional literature necessary for generating income. Other indirect costs can also be deducted in taxation, if they are only related to generating income. For example, the membership fee of the Share Savers Association can be deducted as such an income-generating expense.