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 fund 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 strategies like short selling, 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. If 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 loss if the asset is sold for a loss.
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- There are not listed in the stock exchange 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 companies 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 banks. They meet the needs of the investors with a customized product mix. It depends on the risk tolerance of the investor. 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 investors and retail investors and also underwritten by banks who 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.
- 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 many 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 top 6 high-risk investments along with their advantages and disadvantages. You can learn more about budgeting from the following articles –