High-Risk Investments Definition
A High-Risk Investment is an investment where the degree of risk is high, and there is a high chance that an investor could lose substantial/all amount invested. In High-Risk Investments, the chances of underperformance are higher than the usual. Such investments shall be made by investors who have a high-risk appetite.
Examples of High-Risk Investments
Let us now understand in detail about high-risk investments with the help of a few examples:
Example #1 – Hedge Funds
A hedge fund is an investment fundHedge Fund Is An Investment FundA hedge fund is an aggressively invested portfolio made through pooling of various investors and institutional investor’s fund. It supports various assets providing high returns in exchange for higher risk through multiple risk management and hedging techniques. that coalesces funds from investors such as institutional investors and invests in a varied type of assets and is managed by a professional investment management firm.
- Hedge funds employ strategiesHedge Funds Employ StrategiesHedge fund strategies are a set of principles or instructions followed by a hedge fund in order to protect themselves against the movements of stocks or securities in the market and to make a profit on a very small working capital without risking the entire budget. like short sellingShort SellingShort Selling is a trading strategy designed to make quick gains by speculating on the falling prices of financial security. It is done by borrowing the security from a broker and selling it in the market and thereafter repurchasing the security once the prices have fallen., trading in derivatives, trading in the OTC market, etc.
- Hedge funds are usually open-ended and allow additions and withdrawals by the investors.
- Hedge funds are structurally complex and hence riskier. Suppose an investor is an aggressive risk-seeker. The lock-in period is relatively longer, and if not invested in vigilantly, can lead to huge or complete losses.
Example #2 – Real Estate based Securities/Land Banking.
Real estate based securities are investments in projects like a REIT, a Mortgage investment company, etc. The investors may receive payments on par with rent and/or mortgage payments. He/she may receive capital gains if the asset is sold for a gain or might suffer a capital lossCapital LossCapital Loss is a loss when the value of the consideration received from the result of the transfer of capital assets is less than the aggregate value of the cost of acquisition & cost of the improvement. In simpler words, it can be stated as the loss derived from the transfer of capital assets. if the asset is sold for a loss.
- There are not listed on the stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ., and hence they cannot be sold easily.
- Such investments are not usually guaranteed, and as a result, an investor may lose all his money.
- Also, it might take a very long time to recover the investment.
Example #3 – Private Company Investments
This is a way private companiesPrivate CompaniesA privately held company refers to the separate legal entity registered with SEC having a limited number of outstanding share capital and shareowners. raise money from investors. Returns from such investments are uncertain and hence very risky. Investors should invest only if they can afford to lose all of their investment.
Example #4 – Crowdfunding
Investing in a new business or a start-up with an expectation to earn interest and participation in the future profits of the business. It may have the rule to hold on the investment for an indefinite period, and the returns are always uncertain.
Example #5 – Structured Investment Products
They are also known as market-linked investments and are often created by investment banksInvestment BanksInvestment banking is a specialized banking stream that facilitates the business entities, government and other organizations in generating capital through debts and equity, reorganization, mergers and acquisition, etc.. They meet the needs of the investors with a customized product mix. It depends on risk tolerance.Risk Tolerance.Risk tolerance is the investors' potential and willingness to bear the uncertainties associated with their investment portfolios. It is influenced by multiple individual constraints like the investor's age, income, investment objective, responsibilities and financial condition. The benefits vary from one product to another. They are usually not liquid, and the fee may be quite exorbitant.
Example #6 – Initial Public Offerings
Shares are sold to investors like institutional investorsInstitutional InvestorsInstitutional investors are entities that pool money from a variety of investors and individuals to create a large sum that is then handed to investment managers who invest it in a variety of assets, shares, and securities. Banks, NBFCs, mutual funds, pension funds, and hedge funds are all examples. and retail investors and also underwritten by banks that arrange such shares to be listed on stock exchanges. This enlarges and diversifies the equity base of the company. But there is uncertainty as to whether the management will perform all the necessary duties to develop the company and earn sufficient returns.
Other examples include cryptocurrencies, foreign exchange, ETFsETFsAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange., Venture CapitalVenture CapitalVenture capital (VC) refers to a type of long-term finance extended to startups with high-growth potential to help them succeed exponentially. , Angel investingAngel InvestingAngel investors refer to wealthy investors who supply capital to budding businesses in return for a portion of their equity. , Spread bettingSpread BettingSpread betting is a derivative technique that is more or less a sort of betting on future market movements. In this case, the participants do not actually own the assets that they are using for betting purposes; in other words, it may be learned as a type of betting that involves placing a bet on price shifts in a stock or a commodity., etc.
- Huge Gains– There is a high chance of earning a higher return than normal.
- Easy Buying and Selling- Investor usually has the option to buy or sell the securities without any restrictions.
- There is a benefit of earning Capital gains and dividends.
- Limited Liability- Investor’s risk is limited to the amount of the initial amount invested.
- Highly Volatile – Such investments fluctuate unpredictably and are much volatile when compared to other investments.
- Less Control on the Outcome and Performance – As investors, we would not have much knowledge about the working of the company, and factors deciding the success of an investment would be beyond the control.
- Investors to be last to be paid in the Case of Investment in Equity – In the case of liquidation, equity holders will be paid after all the creditors, suppliers, employees get their share. Though the amount can be withdrawn at any time, anticipating the performance of a fund would be difficult.
This has been a guide to what is High-Risk Investments and its definition. Here we discuss various examples of the top 6 high-risk investments along with their advantages and disadvantages. You can learn more about budgeting from the following articles –