Which Type of Investment Has the Highest Risk?

Which Type of Investment Has the Highest Risk hologram

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.

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.

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