The risks
So what are the risks of investing in shares?
There are two main ones. First, there is a risk you might invest in a company that experiences severe financial difficulties. But despite the headlines surrounding the demise of companies such as One.Tel and HIH Insurance, such corporate bankruptcies are relatively rare—at least if you stick to quality businesses (we’ll talk about how to spot quality businesses later).
Second, and probably of more general concern, is the significant volatility of share prices. Large price fluctuations over a year might seem surprising, because the underlying value of the business you part-own is much less volatile. If you can’t cope with some price volatility then shares may not be for you. But before you opt out, consider this:
If you really are a part-owner, try to think like one. Part-owners focus on the underlying performance of their business, not how much someone is willing to pay for it day-to-day.
Short term price quotations are just that. As an owner you should be more interested in what the business will be worth in five years, not five minutes. So, you can reduce the risk of share price volatility by focusing on the long term. Over that period price fluctuations don’t really matter anywhere near as much. But it takes a certain mental fortitude to hang on when everyone else is panicking (see our section on ‘Successful Investors’ for more on this fascinating topic).
Likewise, you can reduce your risk of a company going bankrupt. Don’t invest in any business with too much debt, and hold a spread of different companies (‘diversification’). That way, if one gets into trouble, you won’t lose a large proportion of your total capital.
