Risky investing opportunities and how to avoid them

To keep extra risk at bay, steer clear of these not-so-great investing opportunities

Some investing opportunities steer investors toward danger.

From the trait of (misplaced) inventiveness to aggressive portfolios to bond investing, it’s important to understand the investing actions that will lead you to take on too much risk.


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Inventiveness and how it impacts investing opportunities

The inventiveness trait can expand your risk in two basic investment opportunities.

First, a financier, inventor or stock promoter can imagine a technological breakthrough long before technology has advanced enough to achieve it. (That’s especially true if he or she stands to gain financially from the coming breakthrough.) But the idea is the easy part. The company has to get the right group of people involved before it can hope to achieve the breakthrough. Even then, technological success and financial success are two different things. The company has to be able to put the breakthrough to use in a product that it can offer at a price that customers are willing to pay.

This is why you need to look beyond the enthusiasm of insiders before deciding to buy a stock. Of course, we take our caution a step further. For one thing, we never recommend stocks whose survival depends on the success of a single product. Instead, we mainly confine our buying to well-established companies that have a history of sales and earnings, if not dividends.

Second, while investors have a knack for envisioning progress, they are also good at predicting doom. At any given time, some investors are creating and spreading ideas that suggest the market is headed for a deep slump.

Many of these ideas grow out of investor regret. You may find it comforting to believe that the market has gone up too high (or for too long, or too fast). After all, this gives you reason to hope that it will come back down again, and give you another crack at the bargains you missed out on when prices were lower.

Other predictions of doom grow out of the belief that you have figured out what the market is likely to do next. The trouble is that nobody can predict the future. The best you can do is take the limited range of information that’s available, and guess at or ignore anything that’s missing. This leaves lots of room for error.

Anybody can guess right on occasion, of course. Many successful financial careers have been launched on the back of a lucky guess or two. But nobody guesses right consistently. That’s why most predictions of doom, like most speculative startups or penny stocks, are utter failures.

Aggressive investing opportunities will also increase your risk, but you can apply a conservative approach to them

The percentage of your portfolio that should be held in either conservative or aggressive investments depends on your personal circumstances. An investor with a longer time horizon or without the need for current income from a portfolio can invest more money in aggressive investing stocks.

However, you can cut your risk all the more by taking a conservative approach to your aggressive investing.

For instance, you should hold your aggressive investments within a portfolio that reflects our three-pronged Successful Investor wealth-building philosophy. That is, invest mainly in well-established companies; spread your money out across most if not all of the five main economic sectors (Manufacturing, Resources, Consumer, Finance, Utilities); downplay stocks that are in the broker/media limelight. That way, you protect yourself from an unforeseeable industry downturn. You also increase your chances of stumbling upon a market superstar—a stock that does much better than average.

You may stretch these rules a little in aggressive investing, while still sticking to the general principles. You may invest in more companies that are less well-established, compared to a conservative investor. But avoid loading up on penny stocks, recent new issues or any stocks that expose you to a serious risk of total loss.

Stocks are better investing opportunities than bonds because bonds can suffer greatly from inflation

Stocks can suffer in a period of rising inflation, of course. But they can still gain if the companies adapt to inflation, as well-managed companies are likely to do. In any event, the value of corporate assets can rise along with inflation. Bonds, in contrast, inevitably lose due to inflation. Their value is denominated in cash—interest payments and the repayment of principal at maturity— and inflation shrinks the purchasing power of cash.

Some investing opportunities aren’t really opportunities at all. What’s one opportunity you have passed on that turned out bad?

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