Stock Market Investing 10 Minute Guide
Authors: Saenz E.A.
 Published year: 2000
 Pages: 71-73/130
Buy this book on amazon.com >>
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Inflationary Risk

We are all too familiar with inflation. However, most people are unaware of how inflation can negate an investment. Say you have 0 and think you might want to purchase a stereo. The stereo you can get for 0 is kind of nice, but what you've really got your eye on is the stereo that costs 0. You decide to invest that 0 and wait until you make in capital gains, at which time you will withdraw the as well as the original 0 and purchase the stereo (let's skip the broker fees for this example). Then, let's say it takes six months for your stock to appreciate.

Plain English

To appreciate means to increase in number or value and thus become more valuable .


But, in the time it has taken your 0 to turn into 0, inflation has driven the price of the two stereos to 0 and 0, respectively. You are worse off than had you not invested and just bought the cheaper stereo. True, you've got 0, which is still more than you had, but that won't buy any kind of stereo now. That's inflation risk. For the record, since the stock market is driven by the economy, stocks carry the lowest inflation risk of any type of investment.

CAUTION

The risk of inflation means that your investment will not maintain its initial purchasing power because it is not growing as fast as the inflation rate.


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I l @ ve RuBoard

Political/Governmental Risk

The American government is about as stable as can be. Other governments around the world aren't quite as lucky, however, and the strange things that foreign governments do can absolutely affect stock investments. The most obvious risk is to those investors who have invested in stock markets in other countries , but the effects of political and governmental risk go way beyond direct cause and effect.

For example, say you have invested in the good old American Widget Company because you don't want to deal with the headaches of international investing. You don't care that the government of North Svengobia has just sealed its borders to all trade with the United States over a territorial dispute. Did I mention that North Svengobia is the only country in the world where the Widget flower, which is so important in the production of Widgets, grows?

TIP

Political and governmental risk is the danger that decisions by governments over which you have no control will have ramifications that will affect your stock domestically.


This is a very real example. There were some very unhappy pistachio nut investors in the United States when Iran stormed the U.S. embassy in the 1970s, effectively destroying all diplomatic relations with the United States and severing a supply line of pistachio nuts. Other examples of political and governmental risk that would affect American investors include unstable exchange rates, nationalization of industries, and trade agreements such as NAFTA. As increasing globalization causes our world to continue to shrink, the power of governmental and political risk will only grow larger.

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I l @ ve RuBoard

Market Risk

Market risk comes in two parts . The first part of market risk lies in the interdependence of all stocks. Although it is true that the value of each stock is independent, the reality is that all stocks in the market share one thing in common ”they are all on the market together. As such, it is impossible to disregard the effect that the overall movement of the market has on your individual stock.

TIP

Market risk is the danger that your stock's performance will be skewed as a result of the conditions of the markets in which it trades.


This effect means that, to some extent, when the entire market goes up, your stock probably will too; and when the entire market goes down, your stock probably will too. This rule isn't set in stone. Some investors make a killing on the same day others are losing their shirts, but realistically the movement of the market is nothing more than a summary of the movement of the stocks within it. Finding a stock that behaves differently from the rest of the market, then, is going to be very difficult to do.

The risk here is that while your stock may be well thought out, in a really good company, and ready to grow, the pull of the market, should it go down, could be strong enough to take your stock with it. Think of it like all those lifeboats floating around after the Titanic went down. They were floating fine on their own; it was the pull of the Titanic that sucked them under.

The second part of market risk lies in trying to sell your stock. When the market is spiraling down, quite frankly, there aren't a whole lot of people who are looking to get in. While conventional wisdom holds that this is exactly the time people should be getting into the market, few do. As a result, you may have a very difficult time trying to sell your stock. This is referred to as an illiquid market.

TIP

An illiquid market, or a market in which few people are buying and/or selling stock, usually occurs when stock prices are shooting up or plummeting down. If prices are plummeting, it's a good time to buy more stock.


Attempting to sell your stock under these conditions usually means that you will have to pay larger transaction fees, reduce the price you will accept for the stock, or anything else you can think of to make your stock more attractive to potential buyers . This, of course, means a loss of money to you.

The 30-Second Recap

  • Determining your investment objectives includes determining what you want your stock to accomplish, and which stocks will best achieve that goal.

  • Ensure that you pick realistic, measurable goals which are part of a larger goal and still able to change when necessary.

  • Examples of the different types of stock include: income stocks that focus on paying out profits in larger regular dividend payments, growth stocks that reinvest most or all of their profits into the corresponding company to provide higher capital gains, and speculative stocks that have little or no real value, but offer the possibility of high returns through high risk.

  • Risk and return is the concept by which your potential for profit rises and falls in direct proportion to the potential to lose money. You must determine where on the spectrum you want your investments.

  • Different types of risk you should consider include: Inflation risk, which means that your profits won't stay ahead of the inflation rate, politial and governmental risk, which include repercussions over domestic and political decisions, and market risk, which includes conditions in the market over which you have no control.

I l @ ve RuBoard
Stock Market Investing 10 Minute Guide
Authors: Saenz E.A.
 Published year: 2000
 Pages: 71-73/130
Buy this book on amazon.com >>

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