Equity investments represent ownership stakes in an entity, entitling investors to a share in profits and losses of the investment. For instance, an individual who co-owns a business with other partners – such as a doctor, lawyer or architect – is an equity investor in the business entity. Similarly, entrepreneurs hold equity ownership in their own companies. Real estate developers often establish an entity to hold one or multiple properties, and secure financing from investors who are promised a percentage of the profits after the properties are developed and/or sold. In such scenarios, the investors become equity owners as well.
Risk
Equity investments, such as investing in stocks or equity mutual funds, carry certain risks that can result in losses for investors. Here are some key risks associated with equity investments:
- Market Risk: Equity investments are subject to market risk, which refers to possibility of the overall stock market declining. Factors such as economic conditions, political events and investor sentiment can influence stock prices. If the market experiences a downturn, the value of equity investments can decline; resulting in losses for investors.
- Company-specific Risk: Investing in individual stocks exposes investors to company-specific risks. These risks can include poor financial performance, management issues, change in competitive dynamics, regulatory changes or adverse events specific to the company. If the company’s performance deteriorates or faces challenges, the stock price may decline – leading to losses.
- Volatility Risk: Equity investments can be subject to price volatility; meaning that their prices can fluctuate significantly over short periods. Volatility can be influenced by various factors, including market conditions, investor sentiment, and news or events related to the company or industry. Higher volatility increases the potential for significant price-swings, which can result in losses if the investor sells at a lower price than the purchase price.
- Liquidity Risk: Equity investments can face liquidity risk, especially for investments in smaller companies or less-actively traded stocks. Liquidity risk refers to the possibility of not being able to buy or sell shares at desired prices or volumes. If the market for a particular stock becomes illiquid or experiences low trading volumes, investors may face challenges in executing transactions; potentially leading to losses.
- Currency Risk (for international investments): Investing in foreign stocks exposes investors to currency risk. Fluctuations in exchange rates between the investor’s home currency and currency of the foreign stock can impact returns. If the investor’s home currency strengthens against the foreign currency, it can result in lower returns when the investment is converted back to the home currency.
- Dividend Risk: Many companies distribute dividends to their shareholders. However, the payment of dividends is not guaranteed; and companies may reduce or eliminate dividend payments based on their financial performance or strategic decisions. Investors relying on dividends for income may face a risk of lower or no dividend payments, which can affect the overall returns and potentially result in losses.
- Timing Risk: Timing the market refers to attempting to buy or sell investments based on predictions of future market movements. Timing the market accurately is challenging, and making incorrect timing decisions can lead to losses. Trying to time the market exposes investors to the risk of missing out on potential gains, or selling at a loss if the market moves in an unexpected direction.
It is important for investors to understand and assess these risks before investing in equities. Diversification, conducting thorough research, analysing company fundamentals and having a long-term investment approach can help manage and mitigate potential losses in equity investments. Additionally, seeking professional advice and staying informed about market and economic developments can be beneficial for making informed investment decisions.
The writer is an Economic Policy & Financial Analyst
