3 Risks When Investing in Stocks

Since its inception in 1987, the Straits Times Index  (SGX: ^STI), Singapore’s most widely used stock market barometer, has delivered more than 7% annual returns. However, the gain only tells half the story.

In investing, there are always risks and potential losses involved. Let’s take a look at some of the risks associated with investing in stocks.

Interest rate risks

Interest rates, in theory, can affect the price of stocks. When interest rates rise, investors can earn better returns on investments by buying bonds and other income-producing assets. Therefore, they may shift their money away from stocks to these assets, affecting the price of the stock market.

Interest rates can also affect businesses that borrow heavily. An uptick in interest rates can cause these businesses to incur higher interest expense, which can widen losses or eat into profits.

Commodity price risk

Many stocks are linked to the price of commodities. Commodities such as oil and gas, and certain raw materials can affect the cost of production of goods. A slight change in these prices can have a rippling effect on a company’s profits.

There are also companies that operate in commodity-related fields. These companies are more at risk to fluctuations in commodity prices.

Foreign exchange risk

Companies often operate in multiple countries, and this exposes them to foreign exchange risk. To curb this risk, some companies may use hedging methods to fix the exchange rate. Even then, most companies are unable to reduce the risk fully.

Investors who invest in stocks outside their own country may also need to purchase shares in a foreign currency. When they sell those stocks, it can also cause exposure to foreign currency fluctuations.

The Foolish bottom line

Investing in stocks can be hugely rewarding, especially if you are familiar with choosing the right companies. However, investing does come with its risks. As investors, we need to be familiar with those risks and not be fooled into thinking that we can earn good returns without the proper know-how.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn’t own shares in any companies mentioned.