In this article:
- High-Risk Investments
- Pros and Cons of High-Risk Investments
- Conservative Investors Should Consider These Lower-Risk Investments
- The Bottom Line
Investment returns are never a sure thing, but certain assets have a reputation for generating hefty rewards. Cryptocurrency and individual stocks are prime examples—we've all heard stories of investors "getting in at the right time" and winning big.
But volatile assets like these also carry the most risk. Take Bitcoin, for example. The price of Bitcoin soared to a record high of $69,000 in November 2021 but dropped to $42,822 by January 2022. That's a 37% downturn in just two months.
You may choose to sprinkle high-risk investments into your portfolio. Instead of going all in, however, experts recommend diversifying your portfolio with lower-risk investments to strike a healthy balance. Here's a rundown of high-risk investments that might be worth exploring.
High-Risk Investments
Individual Stocks
Over the past century, the average annual stock market return has been about 10%. While that may sound enticing, stock investing comes with risk. Purchasing stocks gives you ownership shares in public companies. Share prices rise or fall based on a company's performance and value, market fluctuations and other factors. If you sell your stock for more than you paid, you'll turn a profit (or capital gain). If prices fall, you could end up losing some or all of the money you invested in a given company.
Trying to time the market in this way is virtually impossible, but diversifying your portfolio can help offset losses. It involves spreading out your investments across different sectors, industries and asset classes so that you aren't too heavily invested in stocks or any risky ventures.
Cryptocurrency
Investing in cryptocurrency is extremely volatile. Currency prices can be erratic, bouncing up and down in unpredictable ways. There's also much less oversight when compared with other investments. While the Securities and Exchange Commission closely regulates stock trades, the cryptocurrency market is largely unregulated—and scammers are taking full advantage. There are inherent cybersecurity risks, too, though "cold" crypto wallets that aren't connected to the internet can help keep your money safe.
Private Companies
Entrepreneurs often look to private investors to fund new businesses. In exchange, investors typically receive an equity stake in the company. If you have business knowledge and experience, you may choose to serve as an angel investor. This person typically plays an active role, providing both capital and business guidance. Interested investors can look to their professional network to find opportunities. The Angel Capital Association also connects accredited investors with potential opportunities. Another option is investing in startups through a crowdfunding platform like SeedInvest or StartEngine.
Investing in private companies can be risky because there's no guarantee that the organization will take off as planned. Only about half of new businesses survive five years or longer, according to the Small Business Administration.
Peer-to-Peer Lending
Peer-to-peer lending services and platforms are designed for consumers who are looking for alternative loans. Instead of going to a bank or credit union, they seek funding from investors willing to front the money themselves. The borrower then pays them back with interest. Platforms like Prosper serve as intermediaries so that the two parties never have to interact directly.
Investing in unsecured loans is risky because there's no collateral to back them up. If the borrower defaults, you're on your own. However, most lending platforms have credit requirements to help minimize this risk.
Hedge Funds and Private Equity Funds
Hedge funds pool money together from qualified high-net-worth investors. A fund manager then invests on their behalf, generally in high-risk, high-return investments. Some may use borrowed money on top of the fund's capital, which can amplify potential gains and losses.
Hedge funds aren't for the faint of heart. They could render significant returns, but they aren't regulated as strictly as other investment funds. What's more, hedge funds are known to charge steep fees and are usually only open to accredited investors who have sufficient financial means and investing experience.
Private equity funds are similar in that they're pooled investment vehicles often reserved for accredited investors. They typically zero in on long-term assets with an investment timeline of 10 years or longer. It isn't uncommon for private equity funds to buy into businesses with the goal of increasing their value. Like hedge funds, liquidity can be an issue and regulation is looser.
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Pros and Cons of High-Risk Investments
Pros
- The potential for high returns: Betting big could put you in a position to reap significant investment returns if you're in the right place at the right time. You can control certain factors, like how much you invest and when you decide to buy or sell an investment, but guesswork will always come into play since it's impossible to predict exactly how one of these investments will perform.
- The ability to diversify your portfolio: Diversification is key as it prevents you from keeping all your eggs in one investment basket. Having a healthy mix of investments across different asset classes (stocks, bonds and cash) can help insulate you from market volatility. That said, financial experts typically recommend keeping the highest-risk investments to a low percentage of your overall portfolio holdings.
Cons
- The potential for big losses: High-risk, high-return investments set the stage for potential loss—the more volatile an asset, the riskier it is. It's impossible to predict market fluctuations, economic and governmental changes, business developments, trends and other factors that can affect an investment's performance with complete accuracy. High-risk investments involve a lot of unknowns.
Conservative Investors Should Consider These Lower-Risk Investments
Instead of choosing between high-risk and low-risk investments, many investors simply diversify their portfolios with a mix of both. Safer investments don't generally produce the same kinds of returns, but they're ideal for offsetting losses and protecting your wealth over time.
Before venturing into riskier territory, be sure you have an adequate emergency fund and low debt load—two fundamental pieces of financial health. Also keep in mind that as you near retirement, risky investments have the potential to drastically decrease your future income.
The following lower-risk investment options can help balance your portfolio:
- Bonds: These are debt securities that corporations and government agencies use to raise working capital. The investor buys the bond and is repaid with interest.
- High-yield savings accounts: This type of account is an ideal place to keep your emergency fund because it earns higher interest than a traditional savings account but provides quick access to cash when you need it. Financial institutions may offer rates as high as 0.5% on these accounts.
- Certificates of deposit (CDs): A CD is a savings account that earns interest if you leave your money untouched. Maturity periods range anywhere from one month to upwards of five years, and rates generally increase with longer timelines.
- Mutual funds: Instead of buying individual stocks, mutual funds allow you to invest in small shares of a variety of different assets. Think of it as automatic diversification. An index fund is a unique kind of mutual fund that mirrors a popular stock index such as the S&P 500.
- Exchange-traded funds (ETFs): Like mutual funds, ETFs provide diversification because they're made up of groups of investments. They're also tied to particular market indexes. ETFs can be traded like stocks, which may appeal to some investors.
The Bottom Line
Investing is meant to boost your wealth, but nothing is ever guaranteed. High-risk investments are especially volatile, but they can also trigger significant returns. This is all to say that uncertainty is part of the experience.
Shoring up your financial health can help minimize stress, regardless of your investments. Keep your credit score moving in the right direction by knowing where it's at with Experian's free credit monitoring.
Certainly! Based on the provided article discussing high-risk investments, their pros and cons, as well as lower-risk investment alternatives, here's an overview and additional information on the concepts involved:
High-Risk Investments
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Individual Stocks: Investing in individual stocks provides ownership in public companies. Stock prices fluctuate based on company performance, market trends, and various external factors. While historically the stock market has returned around 10% annually, investing in stocks involves the risk of losing some or all of the invested capital.
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Cryptocurrency: Cryptocurrency, like Bitcoin, is highly volatile with erratic price movements. The market lacks regulation and is susceptible to scams and cybersecurity risks. While it has the potential for significant gains, the risks are equally substantial.
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Private Companies: Investing in private companies, especially startups, involves providing funding in exchange for equity. However, there's no guarantee of success, as many new businesses fail within the initial years.
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Peer-to-Peer Lending: Platforms like Prosper facilitate lending money directly to individuals. While this offers an alternative investment opportunity, it carries risks due to the absence of collateral, potentially resulting in losses if borrowers default.
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Hedge Funds and Private Equity Funds: These investment vehicles pool money from high-net-worth individuals and aim for high returns through riskier investments. However, they often have limited accessibility, high fees, and lower regulatory oversight.
Pros and Cons of High-Risk Investments
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Pros: High-risk investments offer the potential for significant returns and can be a part of diversifying a portfolio. They allow some control over investment decisions.
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Cons: There's a substantial risk of significant losses due to market volatility, unpredictability, and various external factors that can impact investment performance.
Lower-Risk Investment Options
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Bonds: Debt securities issued by corporations or governments, providing fixed interest payments.
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High-yield Savings Accounts: Offering higher interest rates compared to traditional savings accounts, providing liquidity and higher returns.
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Certificates of Deposit (CDs): Savings accounts with fixed interest rates for a specified period, offering higher rates for longer-term commitments.
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Mutual Funds: Investment vehicles allowing diversification by investing in various assets simultaneously.
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Exchange-Traded Funds (ETFs): Similar to mutual funds but traded like stocks, often tracking specific market indexes.
The Bottom Line
Investing involves inherent uncertainties. While high-risk investments offer potential for significant returns, lower-risk options like bonds, savings accounts, CDs, mutual funds, and ETFs provide stability and diversification to a portfolio. As such, striking a balance between high and low-risk investments is often recommended to manage risk effectively.
As for my expertise, I have a solid understanding of investment principles and financial markets, including the dynamics, risks, and rewards associated with various investment instruments, having extensively studied and kept abreast of financial trends and practices up to my last update in January 2022.
