High Risk Investments

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High-Risk Investments Definition

A High-Risk Investment is an investment where the degree of risk is high, and there is a high chance that an investor could lose substantial/all amount invested. In High-Risk Investments, the chances of underperformance are higher than usual. Such investments shall be made by investors who have a high-risk appetite.

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  • A high-risk investment is one where there is a strong likelihood that the investor will lose most or all of their initial investment. 
  • The likelihood of underperformance is more significant than typical in high-risk investments. Investors with a substantial risk appetite should make these kinds of investments.
  • Shares are sold to institutional and individual investors and underwritten by banks, who coordinate the shares' listing on stock exchanges. Therefore, this broadens and diversifies the company's equity base.
  • In the event of a liquidation, equity holders will be compensated following the distribution of shares to all creditors, suppliers, and workers. Even though the money can always be taken out, predicting how a fund would perform would be challenging.

Examples of High-Risk Investments

Let us now understand in detail about high-risk investments with the help of a few examples:

High-Risk-Investments

Example #1 - Hedge Funds

A hedge fund is an investment fund that coalesces funds from investors such as institutional investors and invests in a varied type of assets and is managed by a professional investment management firm.

  • Hedge funds employ strategies like short selling, trading in derivatives, trading in the OTC market, etc.
  • Hedge funds are usually open-ended and allow additions and withdrawals by the investors.
  • Hedge funds are structurally complex and hence riskier. Suppose an investor is an aggressive risk-seeker. The lock-in period is relatively longer, and if not invested in vigilantly, can lead to huge or complete losses.

Example #2 - Real Estate based Securities/Land Banking.

Real estate based securities are investments in projects like a REIT, a Mortgage investment company, etc. The investors may receive payments on par with rent and/or mortgage payments. He/she may receive capital gains if the asset is sold for a gain or might suffer a capital loss if the asset is sold for a loss.

  • There are not listed on the stock exchange, and hence they cannot be sold easily.
  • Such investments are not usually guaranteed, and as a result, an investor may lose all his money.
  • Also, it might take a very long time to recover the investment.

Example #3 -  Private Company Investments

This is a way private companies raise money from investors. Returns from such investments are uncertain and hence very risky. Investors should invest only if they can afford to lose all of their investment.

Example #4 - Crowdfunding

Investing in a new business or a start-up with an expectation to earn interest and participation in the future profits of the business. It may have the rule to hold on the investment for an indefinite period, and the returns are always uncertain.

Example #5 - Structured Investment Products

They are also known as market-linked investments and are often created by investment banks. They meet the needs of the investors with a customized product mix. It depends on risk tolerance. The benefits vary from one product to another. They are usually not liquid, and the fee may be quite exorbitant.

Example #6 - Initial Public Offerings

Shares are sold to investors like institutional investors and retail investors and also underwritten by banks that arrange such shares to be listed on stock exchanges. This enlarges and diversifies the equity base of the company. But there is uncertainty as to whether the management will perform all the necessary duties to develop the company and earn sufficient returns.

Other examples include cryptocurrencies, foreign exchange, ETFs, Venture Capital Angel investing, Spread betting, etc.

Advantages

  • Huge Gains- There is a high chance of earning a higher return than normal.
  • Easy Buying and Selling- Investor usually has the option to buy or sell the securities without any restrictions.
  • There is a benefit of earning Capital gains and dividends.
  • Limited Liability- Investor’s risk is limited to the amount of the initial amount invested.

Disadvantages

  1. Highly Volatile - Such investments fluctuate unpredictably and are much volatile when compared to other investments.
  2. Less Control on the Outcome and Performance - As investors, we would not have much knowledge about the working of the company, and factors deciding the success of an investment would be beyond the control.
  3. Investors to be last to be paid in the Case of Investment in Equity - In the case of liquidation, equity holders will be paid after all the creditors, suppliers, employees get their share. Though the amount can be withdrawn at any time, anticipating the performance of a fund would be difficult.

Frequently Asked Questions (FAQs)

Are high-risk investments worth it?

Determining whether high-risk investments are worth it depends on several factors, including your financial goals, risk tolerance, investment horizon, and overall investment strategy. Here are some considerations to help you evaluate whether high-risk investments are worth pursuing:
1. Return Potential
2. Investment Goals
3. Diversification
4. Time Horizon
5. Risk Management

Are bonds high-risk investments?

Generally, bonds are considered lower-risk investments than other investment options, such as stocks or commodities. When you invest in a bond, you are lending money to the issuer in exchange for periodic interest payments and the return of the principal amount at maturity.

What are the potential rewards of high-risk investments?

High-risk investments offer the potential for higher returns compared to more conservative investments. The increased risk is often associated with the possibility of achieving substantial gains, capturing opportunities for rapid growth, or investing in undervalued assets. Higher risk can be accompanied by higher reward potential, but it is not guaranteed, and losses are also possible.