The definition of high-risk investments are investments with a high probability of failure. Usually, though, the high risk also comes with potentially large yields if the bet succeeds. It’s a high-risk, high-reward proposition, and not for the faint of heart.
To buy high-risk investments without losing your shirt, consider how the risks and rewards fit into your overall portfolio. Once you do that, you can dig into the different high-risk investment options, like turnaround stories, or an ambitious young company that wants to change the world.
Don’t risk what you can’t lose, and don’t limit yourself to just one high-risk investment
Fundamentally, all high-risk investments have two things in common. First, they’re more likely to lose money than more conservative investments; and second, if they do succeed, the potential profits can be very lucrative.
Therefore, investors should try to maximize the upside of their high-risk investments while mitigating the downside if these investments fail. To do this, high-risk investments should be kept to a relatively small portion of the investment portfolio, and that allocated capital should be spread out between several high-risk investments.
How much capital should be allocated? My recommendation is to limit high-risk investments just to capital that you can afford to lose. These investments lose money all the time, and it’s just not worth it to risk your nest egg on something so risky. Investors should be realistic about this.
The number of high-risk investments within that allocation will vary from investor to investor, but the objective of this strategy is to increase the chances of betting on a multi-bagger stock. Making several small bets increases the chance of success without increasing risk. In this way, investors can enjoy the upside of these high-risk bets without losing their shirts if these bets don’t work out.
Turnaround stories are a common example of high-risk investments
High-risk investments can come in many shapes and sizes. One example is investments in turnaround stories, where an existing company has faltered, but is trying to turn itself around with a change in strategy.
Phone-maker BlackBerry (NASDAQ: BBRY) is a great example. The company was once the leader in mobile phones, but has fallen dramatically as Apple‘s iPhone and Alphabet‘s Android platform have come to dominate the market. Blackberry today is over 95% off its all-time highs from 2009.
In response, the company has changed its strategy from competing in the mass market mobile phone market to a focus on providing secure mobile communication services for enterprise clients. Cybersecurity is a huge focus for corporate entities around the world, and if successful, Blackberry could reap huge financial rewards. Plus, with a price-to-earnings ratio of just 4.6 times, the company is cheap.
The risks, however, are tremendous, and the likelihood of Blackberry returning to its former glory is low. When was the last time you saw anyone using a BlackBerry phone, after all?
Turnaround strategies are never easy, but for the right company pursuing the right strategy, the potential upside could be worth the risk for certain investors.
Young companies with huge ambitions are another example of a high-risk investment
On the other end of the spectrum, companies that aim to fundamentally change the world are also high-risk investments. There’s perhaps no better example than Tesla Motors (NASDAQ: TSLA), which aims to bring a global fleet of automated, on-demand, electric vehicles to the world.
This plan could disrupt, and even replace, huge existing industries. Founder and CEO Elon Musk’s “Master Plan,” updated this month, sets the company’s sights on the utility industry, the taxi industry, the auto-manufacturing industry, and the trucking industry. There’s no lack of ambition here, and if successful, the rewards could be astronomical.
But the chance of failure is also extremely high. Electric vehicles have never found a mass market anywhere in the world, and the established players in each of these industries will not simply go down without a fight. David may have defeated Goliath, but Tesla is preparing to fight not a single Goliath, but an entire army of them.
Whatever high-risk investment you choose, remember this: Do your homework, understand both the risks and the rewards, and only bet money that you can afford to lose. If you do this, you’ll be able to invest in high-risk stocks without losing your shirt.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Jay Jenkins has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Apple, and Tesla Motors. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.