Guide to High-Risk Stocks

High-risk stocks are equity investments where investors can experience significant losses, if not all their money. Generally, high-risk stocks tend to be from cyclical, volatile industries or be newer, untested companies. In contrast, lower-risk companies tend to be more established businesses with steady earnings and often distribute a shareholder dividend.

Investing almost always involves risk. The question for most new investors will be how much risk they are willing to take on. If you’re looking to take on substantial risk to reap potential rewards, you may want to look at high-risk stocks. Of course, it’s important to remember that the more risk you take on, the more you stand to potentially lose money.

Why Invest in High-Risk Stocks

Investors may invest in high-risk stocks and similar securities because they may provide substantial returns.

However, very few people put 100% of their portfolios into high-risk investments. Instead, taking on risk is considered part of a broader asset allocation strategy.

Ideally, investors take on just enough risk to potentially increase their returns without ruining their long-term prospects should they lose up to a significant percentage of their allocation to high-risk assets. The balance between safe and risky investments tends to be determined by individual investor goals.

Conventional wisdom often says that younger investors in their 20s or 30s tend to be able to afford greater risks since they will, in theory, have the rest of their working lives to earn back any potential losses. Meanwhile, investors closer to retirement typically focus on safer investments that are likely to produce more reliable, albeit smaller, gains.

A Warning About High-Risk Investments

There are different ways to attempt to measure risk. Some are objective measurements of aspects of a specific investment, while others are more generic insights. Penny stocks and IPOs tend to be riskier than shares of big companies, for example, because their underlying businesses generally aren’t as stable or profitable.

Statistically-based risk measurements, such as standard deviation, seek to assign mathematical value to the risk involved in a particular investment. Calculating portfolio beta is another way to monitor how sensitive your stock holdings are to broader swings in the market.

An important thing to note is that riskier investments are generally considered ones with greater volatility and potential for negative returns.

When it comes to high-risk stocks and other investments involving significant risk, wise investors often follow the adage: never invest more than you can afford to lose. High-risk investors must be prepared for the possibility of losing a significant amount or the entirety of their funds.

Types of High-Risk Stocks and Investments

Highly Volatile Stocks

Experts consider stocks to be some of the riskier assets to invest in, especially compared to bonds or certificates of deposits. But not all stocks are created equal. There are different classes of stocks that are riskier than others. Here are some examples of high risk high reward stocks that tend to be more volatile:

Penny Stocks

Broadly defined as stocks that trade at a market value of less than five dollars per share, penny stocks can be found across all industries. Penny stocks might represent shares of companies in utilities, energy, gold mining, technology, or anything else. Like other high-risk, high-reward stocks, penny stocks can yield high returns in a short amount of time. However, the risks of penny stocks may outweigh the potential for high rewards due to low trade volumes, lack of information on the companies, fraud, and other drawbacks.

IPO Stocks

Investing in stocks of newly public companies can also be risky. These initial public offering (IPO) stocks generally tend to be less tested by the market, making them more prone to price swings or ups and downs in business trends.

Commodity Stocks

In recent years, companies that produce raw materials like oil, grains, and metals have been highly volatile. That’s partly because these commodity industries are cyclical, or closely tied to economic growth. So any sign of slowing growth or perceived signs of slowing growth can cause investors to sell this group.

💡 Recommended: Why Is It Risky to Invest in Commodities?

Cryptocurrencies

Bitcoin and the entire digital currency market have ballooned in the past decade, totaling just under $1 trillion in late June 2022, with nearly 20,000 different coins and tokens in existence.

The trading of cryptocurrencies like Ethereum, Binance Coin, and Dogecoin has seen some engagement among retail investors and even lured professional traders into trying their hand in the market. However, the cryptocurrency market is still very volatile and highly speculative, with digital assets mainly remaining unregulated.

Take Bitcoin, which has the largest market cap and longest track record. In 2017, the coin skyrocketed from around $1,000 at the start of the year to $20,000 by the end. Bitcoin eventually tumbled for pretty much of 2018. In 2020, Bitcoin surged again, and in 2021, it scaled new heights, surpassing $60,000. However, since reaching an all-time high in November 2021, Bitcoin plummeted about 70% by late June 2022.

Ethereum climbed from about $135 at the beginning of 2020 to about $4,800 in 2021. Like Bitcoin, the price of Ethereum dropped substantially since reaching highs in November 2021.

💡 Recommended: Cryptocurrency Glossary

Spread Betting

Spread betting refers to making a bet on the direction of the price of an asset without actually holding it. In spread betting, you make money if the asset moves in the way you predicted, and you lose if it moves the opposite way. Investors can bet on currencies, bonds, commodities, or stocks.

Spread betting is often offered as a leveraged product, meaning investors can trade on margin. If the margin requirement were 10%, for example, a bet of $10,000 could be made with as little as $1,000. This amplifies both losses and gains. When trading on margin, investors are vulnerable to margin calls and can lose more than they initially invest.

Leveraged ETFs

The thing that makes a leveraged exchange-traded fund (ETF) risky is the word “leveraged.” A leveraged investment vehicle offers returns or losses several multiples higher than what someone has to invest.

Leveraged ETFs use debt or derivatives to generate two or three times the daily performance of an underlying index.

There are leveraged ETFs that rise in price along with the assets they track (bull ETFs) and those that rise in price when the assets they follow go down in price (bear ETFs, also known as leveraged inverse ETFs).

Hedge Funds

Think of hedge funds as high-risk funds. A pool of investor money gets invested in different assets. The goal of a typical hedge fund is to get high rates of return for investors by any means possible. That means taking on lots of risk.

There is no established definition of what a hedge fund can invest in. Some hedge funds specialize in asset classes, like junk bonds, real estate, or equities.

In general, hedge funds are only available to accredited investors. That means investors have to fit specific criteria, such as making more than $200,000 per year if the investor is an individual. Certain financial entities like trusts and corporations can also be accredited investors.

Part of what makes hedge funds risky is that they are not subjected to government regulations that offer protection to everyday investors. The reasoning is that only sophisticated investors should be involved in the first place.

Venture Capital

Venture capital is a form of investing that targets a new company and seeks to help it grow.

The requirements for companies to access the public equity markets, meaning they raise money by selling their shares on an exchange where any average investor can purchase them, are high. Most corporations aren’t eligible for this kind of funding, so some of them turn to venture capitalists.

Venture capital funds often receive funding from large institutions like pension funds, university endowments, insurance companies, and financial firms.

The term “venture capital” has become closely associated with the tech industry, as many entrepreneurs in technology that believe they have promising ideas turn to venture capitalists to fund their startups. Traditional business loans often require real assets as collateral, and with many modern companies being information-based, that kind of loan isn’t always an option.

Most new businesses fail, making venture capital investing full of risk. But the possibility of early investment in the next big tech company means the potential reward can also be high.

Angel Investing

Angel investing is a form of equity financing—a way for businesses to fund their operations in exchange for a stake of ownership in the company.

Compared to venture capital, “angel investor” is a more generic term that applies to anyone willing to gamble on a new startup. Angel investors are often high-net-worth individuals looking for significant returns on their investments.

The Takeaway

While high-risk stocks are risky, that might not necessarily mean everyone must avoid them all the time. If you have the risk tolerance, you can utilize high-risk investments to help build wealth and meet your financial goals. Investing in more volatile companies may help individuals benefit from the potential growth of these businesses.

For investors interested in delving into higher-risk investments, like IPO stocks, the SoFi Active Investing platform is a great option. With SoFi online investing, you can also trade stocks, ETFs, and fractional shares with no commissions for as little as $5. For a limited time, funding an account gives you the opportunity to win up to $1,000 in the stock of your choice. All you have to do is open and fund a SoFi Invest account.

Learn more with SoFi Invest®

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