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Risks Associated With Online Investments

Investing in online stocks is a risky business. There are some risks you have some control over and others that you can only guard against. Thoughtful online investments that meet your goals and match your risk profile keep individual stock and bond risks at an acceptable level. However, other risks are inherent to investing for which you have no control. Most of these risks affect the market or the economy and require investors to adjust portfolios or ride out the storm.

Riding the wave of economic risks

One of the most obvious risks of online investing is that the economy can go south. Following the market collapse in 2000 and the terrorist attacks in 2001, the economy saw a downward spiral. A combination of factors saw the market indexes lose significant percentages. It has taken years to return to levels close to pre-9/11 marks.

For novice online investors, the best strategy is often to just hunker down and ride out these downturns. If you can increase your position in good solid companies, these troughs are often good times to do so.

Foreign stocks can be a bright spot when the domestic market is in the dumps if you do your homework. Thanks to globalization, some U.S. companies earn a majority of their profits overseas.

Older investors are in a tougher position. If you are in or near retirement, a major downturn in online stocks can be devastating if you haven't shifted significant assets to bonds or fixed income securities.

Battling the inflation monster

Inflation is taxing on everyone because it destroys value and creates recessions. Although we sometimes believe that inflation is under control, the curse of higher interest rates may at some point be as bad as the problem. Online investors historically have retreated to "hard assets" such as real estate and precious metals, especially gold, in times of inflation.

Inflation hurts investors on fixed incomes the most, since it erodes the value of their income stream. Online stocks are the best protection against inflation since companies have the ability to adjust prices to the rate of inflation.

Although it is not a perfect solution, but that is why even retired investors should maintain some of their assets in stocks.

Profit erosion through Market Value risk

Market value risk refers to a situation where the market turns against or ignores your investment. This happens when the market goes off chasing the latest fad and leaves many good, but unexciting companies behind.

Some online investors find this a good thing and view it as an opportunity to load up on great stocks at a time when the market isn't bidding up the price. On the other hand, it doesn't advance your cause to watch your online investment flatten out month after month while other parts of the market are going up.

The lesson is not to get caught with all your investments in one sector of the economy. By spreading your investments across several sectors, you have a better chance of participating in growth of some of your stocks at any one time.

Guarding against Valuation Risk

Sometimes you will find a company you absolutely love, with excellent margins, fast growth, little debt and a brand that is expanding into a number of new markets. However, the business is trading at a price that is so far in excess of it's current and average earnings, so you cannot possibly justify purchasing the stock.

While you are not concerned about business risk, you are worried about valuation risk. In order to justify the purchase of the online stock at this sky-high price, you have to be absolutely certain that the future growth prospects will increase my earnings yield to a more attractive level than all of the other investments at your disposal.

The danger of investing in companies that appear overvalued is that there is normally little room for error. The business may indeed be wonderful, but if it experiences a significant sales decline in one quarter or does not open new locations as rapidly as it originally projected, the stock will decline significantly. This is a throw-back to the basic principle that an investor should never ask "Is company ABC a good investment"; instead, he should ask, "Is company ABC a good investment at this price?."

There is always some degree present in every online investment you purchase. At the same time, by avoiding or minimizing specific types of risk, you can keep temporary hiccups in the economy or financial markets from destroying your wealth. By learning about the risks of investing and doing your homework on individual investments, you can make decisions that will help you meet your financial goals and still let you sleep at night.