Investing always comes with risk. The question for most new investors will be how much risk they are willing to take on.
Conventional wisdom often says that younger investors tend to be able to afford greater risks, since they will, in theory, have the rest of their working lives to earn back any potential losses in most cases. That assumes that a young investor doesn’t have other debt, which would otherwise eat away at profits.
Investors who are closer to retirement, however, typically choose to focus on safer investments that tend to produce more predictable and reliable, albeit smaller, gains.
Such low-risk investments may include things like government treasury bonds, stocks of large companies and cash held in certificate-of-deposit (CD) savings accounts. Investments like these tend to yield relatively small amounts of interest or dividends while often having reduced risk and volatility.
Investments that carry higher-than-average risk, such as junk bonds, leveraged ETFs, cryptocurrencies and penny stocks, can yield much higher returns. They may also lead to bigger losses.
If you’re looking to take on substantial risk, this article may be a good starting guide. Of course, the more you are willing to risk, the more you stand to potentially lose.
Why would anyone want to invest in high-risk stocks and other securities with similar risk profiles?
First, very few people put 100% of their portfolio into investments like these (unless they really like to gamble and don’t mind potentially going broke). Instead, risk tends to be considered as part of a broader asset allocation strategy.
That’s a fancy term for figuring out how best to invest your money to get the most returns with the least risk.
Ideally, investors take on just enough risk to potentially increase their returns without ruining their long-term prospects should they lose up to 100% of their allocation to high-risk assets. The balance between safe and risky assets tends to be determined by individual investor goals, as mentioned.
Investors with a high risk tolerance have no shortage of investment vehicles to choose from.
Definition of high-risk investments
What makes an investment “high risk?”
First, note that there is no widely-agreed-upon definition as far as what makes an asset “high risk.”
However, there are different ways to attempt to measure risk. Some of them are objective measurements of aspects of a specific investment while others are more generic insights. Penny stocks are riskier than stocks of big companies, for example, because their underlying businesses generally aren’t nearly as stable or profitable.
Statistically-based measurements of risk, such as variance, seek to assign some kind of mathematical value to the risk involved in a particular investment.
An important thing to note is that riskier types of investments are generally considered to be ones that have greater volatility and greater chances to see negative returns.
In other words, when investing in the types of things described here, investors will be likely to see their money take large up-and-down swings in price, and will also be more likely to lose a significant portion of their investment, even if it’s just temporary.
When it comes to high-risk stocks and other investments involving significant risk, wise investors often follow the adage “never invest more than you can afford to lose.”
Let’s really hammer that last point home: high-risk investors must be prepared for the possibility of losing a significant amount or the entirety of their funds.
Types of high-risk stocks and investments
Stocks with high risk and other risky investments come in many shapes and sizes.
There are too many investments of this type to list. And new ones are always being created.
The allure of big profits in a short time has led to the creation of many investment vehicles of questionable quality.
It’s not all that different from the gambling industry. Entire businesses, and even entire cities, have been built up around the glitz and glamor of potentially getting rich quick.
Investors would do well to be wary of anything promising a guaranteed large return on investment in the immediate future. Promises like these might be scams at worst, and when true, tend to involve significant risk.
That said, all investing involves some risk.
Here are several types of high-risk investments.
Think of hedge funds like high-risk funds. A pool of investor money gets invested in different assets. The goal of a typical hedge fund is to get high rates of return for investors by any means possible. That means taking on lots of risk.
There is no established definition of what a hedge fund can invest in. There are hedge funds specializing in all kinds of asset classes, including things like:
• Junk bonds
• Real estate
• Stocks related to a specific industry
In general, hedge funds are only available to “accredited investors.” That means investors have to fit specific criteria, such as making more than $200,000 per year if the investor is an individual. Certain financial entities like trusts and corporations can also be accredited investors.
Part of what makes hedge funds risky is that they are not subjected to the same government regulations that are designed to offer protection to everyday investors. The reasoning behind this is that only sophisticated investors should be involved in the first place.
Bitcoin, the first cryptocurrency, gave birth to an entirely new asset class when it was created in 2009 by a pseudonymous programmer or group of programmers called Satoshi Nakamoto.
Cryptocurrencies are based on blockchain technology, which allows for a distributed network of computers to work together on the same thing.
The entire cryptocurrency market is only worth a few hundred billion dollars, which is tiny when compared to something like the gold market, which is worth well over $7 trillion. Or the real estate market, the largest asset market in the world, which is worth over $200 trillion.
The thin market makes cryptocurrencies very volatile and highly speculative. Bitcoin has the largest market cap and longest track record, making it somewhat less speculative than the hundreds of other cryptocurrencies (many of which have gone to zero or close to it).
What attracts most investors to this market is the potential for outsized gains. During the years of 2017 and 2018, some tokens saw their value increase by huge amounts in short timeframes.
And some hedge funds specializing in cryptocurrencies reported returns of 10,000% or more. By comparison, the average annual return of the S&P 500 index over the past 90 years is about 10%.
Cryptocurrency markets are mostly unregulated and full of potential pitfalls, including many scams and a high rate of failure for most projects.
Venture capital refers to a form of investing that targets a new company and seeks to help it grow.
The requirements for companies to have access to the public equity markets, meaning they raise money by selling their shares on an exchange where any average investor can purchase them, are quite high. The vast majority of corporations aren’t eligible for this kind of funding, so some of them turn to venture capitalists.
Venture capital funds often receive much of their funding from large institutions like pension funds, university endowments, insurance companies and financial firms.
The term “venture capital” has become closely associated with the tech industry, as many entrepreneurs in technology that believe they have promising ideas turn to venture capitalists to fund their startups.
Traditional business loans often require real assets as collateral, and with many modern companies being information-based, that kind of loan isn’t always an option.
Most new businesses fail, making venture capital investing full of risk. But the possibility of getting an early investment in the next big tech company means the potential reward can also be high.
Angel investing is similar to venture capital in that both refer to a form of equity financing — a way for businesses to fund their operations in exchange for a stake of ownership in the company.
The term “angel investor” is a more generic term that applies to anyone willing to take a gamble on a new startup. Angel investors are most often high net worth individuals looking for big returns on their investment. If you’ve ever seen the show Shark Tank, then you’ve witnessed a form of angel investing.
Crowdfunding is a newer form of angel investing whereby many people contribute small amounts of money to a cause. GoFundMe campaigns are an example of crowdfunding.
Spread betting refers to making a bet on the direction of the price of an asset without actually holding it. Investors can make bets on things like currencies, bonds, commodities, or stocks. In spread betting, you make money if the asset moves in the way you predicted, and you lose if it moves the opposite way.
Spread betting is often offered as a leveraged product, meaning investors can trade on margin. If the margin requirement were 10%, for example, a bet of $10,000 could be made with as little as $1,000. This amplifies both losses and gains. When trading on margin, investors can lose more than they initially invest.
It’s basically like flipping a coin with a friend while you make bets on whether it will come up heads or tails, although spread betting is a little more complicated in practice and much riskier.
In fact, spread betting is so speculative that it’s even considered gambling by law in some places. That means realized gains might not be subject to the same capital gains tax that profits on other investments typically are.
Penny stocks are broadly defined as stocks that trade at a market value of fewer than five dollars per share.
These are considered to be high-risk stocks because they:
• Have a small market cap, which means higher volatility in their share price.
• The companies tend to be younger and have had less of a chance to prove themselves.
The term “penny stocks” is broad and applies to stocks across all industries. Penny stocks might represent shares of companies in utilities, energy, gold mining, technology, or anything else.
Like other high-risk, high-reward stocks, penny stocks can yield high returns in a short amount of time. This is partly due to the fact that a small company might see rapid growth, and partly due to the fact that many investors speculate in penny stocks.
Along with cryptocurrencies, penny stocks might be among the most easily accessible risk assets listed here. Anyone can trade them — the only thing required is a brokerage account.
The thing that makes a leveraged ETF risky is the word “leveraged.” A leveraged investment vehicle is one that offers returns or losses several multiples higher than what someone has to invest, as we just described in the section on spread betting.
A leveraged ETF might not necessarily invest in high-risk stocks. No matter what assets they invest in, though, being leveraged involves a higher amount of risk than a similar ETF with no leverage.
Using debt or derivatives, leveraged ETFs attempt to generate, on average, two or three times the daily performance of a given index.
There are leveraged ETFs that rise in price along with the assets they track (bull ETFs) and those that rise in price when the assets they track go down in price (bear ETFs, also known as inverse ETFs).
Unregulated collective investment schemes
If there ever were a great example of a high-risk investment, unregulated collective investment schemes (UCIS) would be it.
A UCIS functions similarly to a mutual fund in that a pool of investor money gets collected and invested in different assets.
However, as the name suggests, there are no regulations in place to safeguard consumers. Investors have to place all of their trust in the people managing the scheme.
Investing in high-risk stocks yourself
While high-risk stocks are, of course, risky, that might not necessarily mean everyone needs to avoid them all the time. As noted before, some experts believe younger investors may have a higher-than-average tolerance for risk.
Financial advisors can recommend a balanced approach to investing based on a person’s individual circumstances and goals.
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA/SIPC. The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
Third Party Trademarks: Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP, CERTIFIED FINANCIAL PLANNER, CFP (with plaque design), and CFP (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA, the SEC, and the CFPB have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
IPOs: Investing early in IPO stock involves substantial risk of loss. The decision to invest should always be made as part of a comprehensive financial plan taking individual circumstances and risk appetites into account.
Featured Image Credit: dima_sidelnikov / iStock.AlertMe