Understanding High-Risk Investments

All investments carry some risk. Investors usually measure the chance of losing money against the potential profits. This risk-reward comparison usually follows the same pattern for all stocks, funds, currencies, derivatives, and other investment vehicles. The more risk an investment presents, the higher the possible reward. 

High-risk investments can offer substantial profits. However, there is a strong chance that the investment will not work out or that you will lose all or most of your capital. The high odds of a losing investment could be due to several factors. These include volatility (quick and unexpected price changes in the security) and a lack of liquidity (difficult to exit losing positions quickly). New investment vehicles that lack research materials can also be highly risky. 

It’s important to understand the risk associated with these volatile assets so that you can manage your overall portfolio correctly. 

The Pros and Cons of High-Risk Investing

The first step in understanding high-risk investing is grasping the advantages and disadvantages it presents. Here are some of the potential benefits: 

• Potential for substantial gains: If you choose the right assets and time your trade correctly, you can make much larger gains than with traditional long-term investing. 
• Chance for short-term growth: High-risk investments offer the chance for quicker payoffs. You may not have to wait years for dividends to accrue or bonds to mature. 
• Opportunities to diversify: High-risk investments are often in new areas, like cryptocurrency or tech startups. You can get into new sectors early to reap the benefits of growth and mainstream adoption. 

While these benefits can be attractive, you need to be aware of the negative side of high-risk investing. 

• Chance of losing your capital: Because of unpredictability or high volatility, there’s a high chance of losing a large portion of your capital. 
• Lack of research materials and regulation: Some high-risk investments, like penny stocks or cryptocurrency, don’t have much data or financial information for analysis. 
• Exposure to stress: The uncertainty of these investments can cause stress as you watch violent price fluctuations or deal with the ongoing concern of potentially losing money. 

You need to carefully consider these pros and cons to help you decide if high-risk investments are the right fit for your portfolio. 

Types of High-Risk Investments

High-risk investments provide the chance of significant profits, but they come with high odds of substantial losses due to volatility, a lack of liquidity, or general unpredictability and uncertainty.  

Because of the chance of significant losses, it is important to not use too much investment capital on high-risk investments. Diversification is key. If you have low-risk investments in your portfolio, you can enjoy steady returns while using smaller amounts of capital on higher-risk investments. 

Here is a look at four categories you might target if you want to use a portion of your capital for investments on the high end of the risk-reward spectrum. 

Cryptocurrencies

Cryptocurrencies are digital assets exchanged on decentralized networks known as blockchains. The most famous cryptocurrency, Bitcoin, has grown since its introduction in 2008; a single coin is now worth tens of thousands of dollars. 

These currencies are often unregulated, and the factors that affect price movements are unclear. Bad actors can manipulate markets, and some digital coins could lose all their value with little warning. 

Bitcoin is the most well-known cryptocurrency, but there are hundreds of others, including some like Ethereum, which has risen to a price of several thousand dollars per coin. 

Penny Stocks

Penny stocks have a unique place in financial markets. These publicly traded assets are worth less than $5 per share. Though some are available through regular stock exchanges, most trade over-the-counter (OTC) on decentralized networks. 

Though they are low-cost, these stocks are often considered high-risk. They lack the scrutiny, history, and financial data of larger corporations, so research and analysis are always challenging. Also, most are illiquid, meaning it’s difficult to close out a position once you purchase the stock — which means it’s difficult to close out a losing trade. 

Private Investments

Companies use private investment capital to fund development and growth. You can invest in startups in exchange for equity. New companies often prefer this as an alternative to business loans because they can focus on growth without worrying about repayment and avoiding the strict requirements of bank-based lenders. 

Investing in young businesses comes with high risks. Though you get shares, they are not liquid, meaning you will not have any interested buyers until the company grows. This is important because two-thirds of startups fail to deliver any profits to their investors. 

Do High-Risk Investments Bring High Rewards?

There is a parallel relationship between risk and reward. In general, the higher the risk of losing money, the greater the potential reward. The risk of losing money on treasury-back bonds is extremely low, but the profits are modest. On the other hand, startup equity can potentially lead to huge profits, but if the company fails, you’ll lose everything you invested.

What Is an Example of a High-Risk, High-Reward Investment?

For example, you purchase a penny stock for $0.10 per share. The company isn’t listed on a national stock exchange, so investors aren’t expecting much from the company. If the company ever gets listed on an exchange and experiences growth, you could earn five or 10 times your initial investment — possibly more. However, many penny stocks end up losing money, so the chances of this windfall are quite low, making it a risky investment. 

The Role of Stock Loans in a High-Risk Investment Strategy

One option for funding high-risk investments is to use part of your portfolio as collateral to borrow money with a stock loan to use as capital to make high-risk investments. While most stock loans are general purpose loans, there are often restrictions from using the proceeds to purchase margin stock. Assets that can only be purchased with cash such as cryptocurrencies, penny stocks, and private investments may be suitable. 

Stock loans offer a few advantages for raising cash. First, you can retain ownership of your stocks if you repay the loan. This means you do not have to sell dividend-earning stocks or assets that offer long-term value. Also, you can get access to capital quickly so that you can obtain high-risk investments when they are advantageously priced. 

Finally, stock loans are often non-recourse loans, meaning you cannot lose more than you borrow if you default. Also, since stock loans are secured, you can get a lower interest rate than with an unsecured loan. However, you should always use a stock loan calculator to see if the amount and interest rate meet your requirements.  

A stock loan can prove capital quickly and allow you to speculate on higher-risk investments while retaining your other investment holdings. On the other hand, you need to remember that high-risk investments do not often work out. There is a risk that you could lose some or all of the money you borrow.

Strategic Considerations for High-Risk Investments

Proper financial management is essential for high-risk investments. The first step is to assess your risk tolerance and balance your portfolio accordingly. There is differing advice for doing this. The Financial Industry Regulatory Authority (FINRA) suggests diversifying with different asset types and different securities within each asset type. For example, you would include a mix of low-risk stocks and high-risk cryptocurrencies in a ratio that fits your risk tolerance. 

You should also seek investments that have a history and have produced data. This will allow you to perform fundamental analysis using financial information and reports and technical analysis using charts and mathematical indicators. This type of due diligence is necessary for all investments, regardless of the potential payoff or level of risk. The research can help lower the risk and avoid investments that exceed your risk tolerance. 

You can make high-risk investments a portion of your portfolio if you properly manage risk and hedge your bets with lower-risk investments.