Investment Risks & Your Money
May 23, 2011
Every investment has some risk, the question for investors is how much risk are you willing to take on in the pursuit of higher investment returns?
As I mentioned in my how to invest post, when you buy stock in a company you have both the potential of profit and the risk of losing money. I used to work for a publicly traded company, and owned some shares of the stock, so I had an interesting perspective on the associated risks and the potential rewards of being a shareholder.
Opportunities & Threats
Whether formally or informally, many companies keep track of their corporate strengths & weaknesses as well as any potential opportunities for growth and pending threats to profits. One name for this is a SWOT analysis (strengths, weaknesses, opportunities, threats) and most companies probably come away from one with a big list of potential threats.
There are many things that can impact the performance of a company that are out of the corporation’s direct control; such as the economy, government regulations, industry trends, natural disasters, and public opinion. I saw the CEO of our company battle with all of the above factors in an effort to earn annual 10% growth for the shareholders.
The strangest one was a YouTube video about one of our customer’s products. It had over 3 million visitors and brought enough bad publicity to the client that they made changes that cost our company a ton of money. Things went from bad to worse a few years later when an economic downturn caused major cost cutting on their part and eventually lost us the client altogether.
I share those stories as illustrations that risks are hard to manage. All of our corporate, group, and individual goals each year were tied to the ultimate goal of annual 10% growth. They had us working full speed ahead to try and make it happen.
The effort was from all levels – quarterly updates from the CEO on a corporate level and from our director at a product level kept our efforts focused. The executives flew all over the country making deals, negotiaing, and trying to keep clients happy – while the rest of us worked like the devil to keep their promises.
Yet, despite our best efforts, our company lost money. We lost clients to competitors, our costs were going up, clients were tightening their belts, regulations made things more expensive, and we were investing heavily in new technology and new processes to remain competitive.
It could be that with a different strategy or a different CEO things would have been different but the point is that it’s hard to tell how various risks will impact the share performance of a company. Every quarter the company leaders would look at past and projected profits, opportunities, and risks and make public statements about where they thought the company was headed. All the first-hand knowledge you have as a shareholder are the numbers you see in a company’s quaterly earnings and the forward looking statements of the CEO.
I learned three main things about investing money in public corporations during my time with the company.
1) Don’t Overlook Risks
Even if a company is in a stable industry, has a big client base, has quality products, and has a strategy that seems solid – coming away with profitable results is uncertain. It can look good on paper but be aware of the things that could go wrong that could send profits south in a hurry.
2) Look for Long Term CEO’s
CEO’s of publicly traded companies are under a lot of pressure to make the numbers and sometimes this creates decisions that result in better short term numbers but weaker long term prospects. If you’re investing for long term profits you want a company leader who’s willing to risk thier neck for the benefit of the company. If you’re thinking about investing in a company, look at the track record of the CEO. Are they willing to make moves that aren’t all about short term stock price in order to put the company in a better position long term?
3) Don’t Bet On One Company
I imagine former employees of Enron would agree with this one. If you put all your trust into one company and it does poorly then you’re out a lot of money. Obviously the Enron example involved fraud but there are companies with legitimate enterprises and good intentions that make bad calls and lose a lot of money. In my opinion, the potential upside of a company stock is not worth the risk of investing all my money in one place – particularly if they’re the source of your primary income.
Stock Investing Alternatives
If you don’t have the time or desire to research a company and investigate things like the risks they face or the history of the CEO, you do have investing options other than individual stocks. In fact, if you’re not willing or able to do the necessary research on a company before buying their stock, it’s probably best that you don’t buy any shares.
The other investment options that I’m referring to are ETF’s and mutual funds. Instead of buying shares in a company, you buy shares of the funds – which then do the research and invest your money. Although these funds evaluate investments for you and diversify your money across a range of companies, you still risk losing money when you invest with them.
Next time we’ll talk more about how to determine how much risk you’re comfortable with and things to consider when investing in mutual funds and ETF’s.
All posts by Ben Edwards