Updated July 17, 2023
What is High Risk Investments?
The term “high risk investments” refers to those investments in which the degree of risk is on the higher side, which means that there is a high chance that the investor might lose the entire or significant portion of the investment due to some particular event.
In other words, the probability of underperformance is much higher in case of high risk investments as compared to other traditional investments. Such investments are appropriate for investors with higher risk appetite.
Explanation of High Risk Investments
Most investments have the potential to generate healthy returns over a longer period of time. However, some investors seek higher yields in a relatively shorter period of time and so they are lured to investments that come with the possibility of unattractive losses. Basically, if an investment offers a higher rate of return in a shorter time horizon, then the investor knows that this a high risk investment.
Example of High Risk Investments
Now, let us look at some of the examples of high risk investments:
- Hedge funds: In this type of investment instrument capital from a large number of investors are pooled into a single fund, which is then invested in a variety of different asset classes. A hedge fund usually employs multiple complex methods for mitigating risk and generating healthy returns.
- Cryptocurrencies: Unlike fiat money, these currencies are digital in nature and they are used independent of the central banking system. The cryptocurrency transactions encrypted into order to maintain its safety.In the last couple of years, cryptocurrency has been gaining popularity, especially Bitcoin. However, its future is still very uncertain, which makes the investment highly risky.
- Venture capital: This type of fund usually invests in private sector companies during their early days and continue with them until the last round of funding before the final exit. Venture capital is considered to be a long-term investment, which is risky in nature as there is high probability that many of the invested companies will return little to nothing. But the expectation is that one or two companies from the portfolio will generate such high returns that losses from the remaining portfolio will be covered.
- Spread betting: This derivative instrument is a form of alternative investment wherein the investor doesn’t own the underlying asset, but simply bets that its price will either go up or down. Given its speculative nature, spread betting is considered a high risk investment.
- Penny stocks: It refers to the type of stocks that trade at a relatively low price, which results in ina low market capitalization. These stocks are usually not traded at the major stock exchanges. Penny stocks are considered high risk investment due to lack of liquidity and risk of large fluctuations in value owing to purchase or sell by larger investors.
- Leveraged exchange traded funds(ETFs): This type of funds seek to increase the returns of an underlying index multiple times by leveraging financial derivatives and debt. Most of the major indexes and their sub-segments offer the investment opportunities of leveraged ETFs. These investments are deemed risky given the leverage finance structure.
- Foreign Emerging Markets: Typically, countries with strong growth potential are considered to be the ideal investment opportunity for this category. The investors tend to purchase government bonds and invest in stocks in countries that are on the hyper-growth path. However, the major risk in such a case is that the period of extreme growth is way shorter than what was anticipated by the investors, resulting in unfavorable returns.
- High Yield Bonds: This type of bonds usually offer outrageous returns in exchange for the potential risk of losing the principal itself. The investors are attracted to these instruments because they offer much higher returns when compared to the low return bonds offered by the government.
Causes of High Risk Investments
The underlying principle of high risk investment is based on the risk-return tradeoff, which states that the rate of return increases with the increase in risk. So, the investors understand the fact that low risk yields low returns, while high risk yields high returns. Consequently, a large number of investors with higher risk appetite are usually attracted by the temptation of high yields within a shorter investment horizon despite the high level of uncertainty that might result in unfavorable losses.
Some of the major advantages of high risk investments are as follows:
- Investors can earn huge returns in a very short period of time.
- In most cases, the investor are able to purchase and sell the securities with ease.
- Investors can earn capital gains as well as dividends on their investments.
- In most cases, the investors’ risks are limited to the initial amount invested (except spread betting).
Some of the major disadvantages of high risk investments are as follows:
- Usually, the fluctuations of high risk investments are very volatile and unpredictable in nature as compared to other investment instruments.
- In some cases (e.g. penny stocks and cryptocurrencies), there is lack of liquidity as they are not traded across larger platforms.
- The investors hardly have any control over the performance of these investments.
- At times, the investors end up borrowing so much that they become overburdened with debt.
- The inexperience of the investor regarding high risk investments can prove fatal for their portfolio.
- In most cases, these investors are subordinated to all other stakeholders in the funds.
So, it can be seen that there is no guaranteed way to earn higher returns on investment. But there are a plethora of options available with their own advantages and limitations. Each option has the potential to generate outrageous returns in a short period of time, but each option comes with its own set of risks and the onus is on the investor.
This is a guide to High Risk Investments. Here we also discuss the introduction and causes of high risk investments along with advantages and disadvantages. You may also have a look at the following articles to learn more –