Investing in the Nigerian stock market can give your money a chance to grow, but it comes with risk. Share prices can rise and fall based on company performance, economic conditions, investor sentiment, and events happening far beyond the stock market itself.
This makes risk management an important part of investing. You cannot control whether a stock’s price goes up or down, but you can control how much money you put into it, how diversified your portfolio is, and how you respond when the market moves against you.
Understanding the risks of investing in Nigerian stocks can help you make more informed decisions and build a portfolio that can withstand periods of uncertainty.
What is risk management?
Risk management is the process of identifying potential risks in an investment and taking steps to reduce their impact on your portfolio.
This does not mean finding investments that cannot lose value, as no stock investment comes with that guarantee. Instead, it involves making decisions that prevent a single poor investment or an unexpected market event from causing significant damage to your overall financial position.
Three things are particularly important when thinking about risk:
- Risk tolerance is how much investment volatility and potential loss you are comfortable experiencing.
- Risk capacity is how much loss you can actually afford based on your income, savings, financial obligations, and investment goals.
- Risk exposure is the portion of your portfolio exposed to a particular investment, company, sector, or type of risk.
For example, an investor may be comfortable with stock market volatility but still have a low risk capacity because they will need the money in a few months. In that situation, investing most of their savings in stocks could expose them to more risk than they can handle financially.
Understanding the difference between these concepts is the first step towards managing the risks of investing in stocks.
The risks of investing in Nigerian stocks
Before discussing strategies for managing risk, it helps to understand where that risk comes from. The following are the types of risk you may encounter when investing in stocks.
1. Market risk
Market risk is the possibility that stock prices will fall because of broader market or economic conditions.
The Nigerian stock market can respond to factors such as inflation, interest rates, foreign exchange movements, economic growth, government policies, and changes in investor sentiment.
Which means that a company can be performing reasonably well while its share price falls because investors are selling stocks across the wider market.
This is one of the risks of investing in Nigerian stocks that cannot be completely eliminated through research. Even a fundamentally strong company can experience price declines during a broad market downturn.
2. Company-specific risk
Every company has its own risks. Poor financial results, management changes, regulatory challenges, increased competition, operational problems, or declining demand for a company’s products can affect its share price.
If you invest heavily in just one company, these problems can significantly impact your portfolio. This is why understanding a company’s business and financial performance is important before buying its shares.
3. Inflation risk
Inflation reduces the purchasing power of money over time. If your investment earns 10% in a year while inflation is 15%, your nominal return may be positive, but your purchasing power has still declined.
For Nigerian investors, this makes inflation an important consideration when evaluating investment returns. The goal should not only be to see your portfolio balance increase, but also to consider what those returns are worth in real terms.
4. Interest-rate risk
Interest rates can influence where investors choose to put their money.
When interest rates and yields on fixed-income investments rise, some investors may find these investments more attractive relative to equities. This can affect demand for stocks and, consequently, share prices.
Changes in interest rates can also affect companies directly by influencing their borrowing costs and profitability.
5. Liquidity risk
Liquidity refers to how easily an investment can be bought or sold without significantly affecting its price.
Some Nigerian stocks trade much more actively than others. A stock with relatively low trading activity may take longer to sell, particularly when you want to exit a large position.
This is another risk of investing in Nigerian stocks that investors should consider before committing a significant amount of money to a particular company.
6. Currency and macroeconomic risk
Exchange-rate movements and broader economic conditions can affect Nigerian companies in different ways.
For example, a company that depends heavily on imported inputs may face higher costs when the naira depreciates. On the other hand, a company that earns substantial foreign-currency revenue may experience different effects.
Understanding how economic conditions affect the businesses you own can help you make better investment decisions.
Related: Types of Risk in Investing
Risk management strategies for Nigerian stock investors
Knowing the risks is useful, but the bigger question is what you can actually do about them.
Here are practical strategies for managing your stock investment risk.
1. Diversify your stock portfolio
One of the simplest ways to manage investment risk is diversification. Instead of putting a large portion of your money into one company, you can spread your investments across different companies and sectors.
This way, if one company or sector performs poorly, the impact on your overall portfolio may be smaller.
However, diversification does not mean buying as many stocks as possible. Owning 30 stocks that are all exposed to the same economic risk may not provide as much diversification as you expect.
However, you can also diversify beyond equities by holding other investments with different risk and return characteristics.
2. Do not invest money you cannot afford to lose
The stock market should not be your emergency fund.
Money set aside for immediate expenses, emergencies, or financial obligations should generally not be invested in assets that can fluctuate significantly in value.
For instance, if you invest money you will need to pay school fees in three months, you may be forced to sell your shares at a loss if the market falls when you need the funds.
Keeping your short-term financial needs separate from your long-term investment capital can help reduce this risk.
3. Invest according to your time horizon
Your investment time horizon is how long you expect to keep your money invested.
Stocks can experience significant short-term price movements. An investor who needs their money in a short time has less room to wait through a market decline than someone investing for the next 10 years.
So, before investing, consider when you will need the money and choose your level of exposure accordingly. A longer time horizon does not eliminate the risks of investing in stocks, but it can give you more time to navigate short-term market fluctuations.
4. Research before buying a stock
A stock is more than a price displayed on your screen. It represents ownership in a business. Before investing, take time to understand what the company does and how it makes money.
Some factors you can examine include:
- Revenue growth
- Profitability
- Debt levels
- Cash flow
- Dividend history
- Management
- Competitive position
- Industry outlook
- Valuation
- Previous financial performance
You do not have to become a professional financial analyst before buying stocks. However, having a basic understanding of the business can help you avoid making decisions based solely on rumors, social media posts, or recent price movements.
Plus, if you need additional guidance, you can get stock recommendations from experienced professionals who conduct thorough market and company research. These recommendations can help you identify stocks that may align with your investment goals, risk tolerance, and overall investment profile.
5. Set limits for individual stocks
Even after thoroughly researching a company, things can change.
One way to manage concentration risk is to decide how much of your overall portfolio to allocate to an individual stock.
For example, an investor may decide that no single company should represent an excessively large portion of their portfolio.
The appropriate percentage depends on your financial situation, objectives, and risk profile. What’s more important is to avoid allowing one investment to become so large that its performance determines the fate of your entire portfolio.
6. Avoid emotional investing
Stock prices can trigger strong emotions. A stock that keeps rising can create fear of missing out (FOMO), making investors feel they have to buy immediately, or a sudden decline can create fear and encourage panic selling.
None of those two reactions necessarily reflects what is happening with the underlying business. Instead of making decisions based entirely on daily price movements, have a clear reason for owning each stock.
Having an investment plan can make it easier to stay disciplined when the market becomes unpredictable.
7. Consider buying in batches
You do not always have to invest your entire intended amount at once. Spreading purchases over different periods can reduce the risk of committing all your money immediately before a significant market decline.
This approach, often referred to as cost averaging, does not guarantee a profit or prevent losses. Its main benefit is reducing the pressure of trying to identify the perfect time to enter the market.
8. Monitor your portfolio without overtrading
Managing risk does not mean watching stock prices every few minutes. In fact, constantly checking prices can encourage unnecessary buying and selling.
Instead, review your portfolio periodically and focus on factors that truly matter, such as company performance, financial results, changes in your investment goals, and shifts in your asset allocation.
9. Rebalance your portfolio when necessary
Your portfolio can change significantly over time. Let’s assume you start with an equal allocation across five stocks. One company performs exceptionally well and eventually represents a much larger percentage of your portfolio. You may now have more exposure to that company than you originally intended.
Rebalancing involves adjusting your holdings to bring the portfolio closer to your preferred allocation. This can help prevent your portfolio from becoming unintentionally concentrated as market prices change.
10. Keep other assets in your overall financial plan
Risk management should not stop at your stock portfolio. Holding other types of investments can provide additional diversification and reduce your dependence on equities alone.
Depending on your financial goals and risk profile, this could include fixed-income investments, mutual funds, or other suitable asset classes. You can access a wide range of these on the Zedcrest Wealth app.
Your objective should be to build an overall financial plan in which no single market determines your entire financial outcome.
11. Get professional guidance
While many risk management strategies can be implemented independently, investors often overlook key details or succumb to their emotions amid volatile markets. That’s where a financial advisor’s guidance can make all the difference.
Professional advisors bring objectivity and discipline to the investment process and help you make rational decisions even when emotions run high.
Thanks to their extensive experience, they can also reassure you during periods of uncertainty, thus reducing the temptation to make rash decisions that can derail your financial plans.
When should you sell a stock?
Risk management goes beyond deciding what to buy. You also need to know when to reconsider an investment.
A falling share price by itself does not necessarily mean you should sell because markets can decline for many reasons, including temporary changes in sentiment.
You may want to reassess an investment when:
- The company’s fundamentals have materially deteriorated.
- Your original investment thesis is no longer valid.
- The investment has become too large a portion of your portfolio.
- Your financial goals or time horizon has changed.
- You have identified a more suitable use for the capital.
The key is to make the decision based on your investment strategy and available information rather than fear or excitement.
Frequently asked questions about the risks of investing in Nigerian stocks
1. What are the main risks of investing in Nigerian stocks?
The main risks include market risk, company-specific risk, inflation risk, interest rate risk, liquidity risk, currency risk, and broader macroeconomic risk. These can affect stock prices and investment returns in different ways.
2. How can I reduce the risks of investing in Nigerian stocks?
You can reduce your exposure to investment risk by diversifying your portfolio, researching companies before investing, setting limits on individual stocks, investing according to your time horizon, and avoiding emotional decisions. Keeping other types of investments in your overall financial plan can also provide additional diversification.
3. Is diversification enough to reduce investment risk?
Diversification can reduce the impact of a poor-performing stock or sector, but it does not eliminate risk. A diversified portfolio can still decline when the broader stock market falls or when economic conditions affect multiple sectors simultaneously.
4. How much of my portfolio should I invest in Nigerian stocks?
There is no single percentage that works for every investor. Your allocation should consider your financial goals, investment horizon, risk tolerance, risk capacity and other assets you own. Investors who may need their money soon may need less exposure to volatile assets than those investing for long-term goals.
5. Should I sell my stocks when the market falls?
Not necessarily. A market decline alone does not automatically mean an investment should be sold. Before making a decision, consider why the stock has fallen and whether the company’s fundamentals or your original investment thesis have changed.
6. How do I choose lower-risk stocks?
No stock is completely risk-free. However, researching a company’s financial performance, debt levels, cash flow, profitability, management, competitive position and valuation can help you better understand the risks associated with an investment.
7. Can I lose all my money investing in Nigerian stocks?
It is possible to lose a significant portion of your investment, particularly if you concentrate your money in a single company that performs very poorly. Diversification and appropriate position sizing can help reduce the potential impact of one investment going wrong.
8. Is investing in Nigerian stocks suitable for beginners?
Beginners can invest in Nigerian stocks, but they should first understand how the market works, learn about the companies they are considering, and invest amounts appropriate to their financial circumstances. Starting with a clear strategy can help reduce the effect of common investing mistakes.
In conclusion
There is no way to remove all risk from stock investing. Every investment decision involves some degree of uncertainty.
The goal of risk management is to ensure that uncertainty does not expose your finances to more damage than you can handle; thus, it should be part of your investment strategy from the beginning, not something you consider only after the market falls.
Now that you understand the risks of investing in Nigerian stocks, it’s time to put your investment strategy into action.
With Zedcrest Wealth, you can trade 150+ Nigerian stocks listed on the NGX, giving you access to a range of companies and sectors from one platform. Also on the app, you can research opportunities, build a diversified portfolio, and manage your investments while keeping your financial goals and risk tolerance in mind.
Download the Zedcrest Wealth app, create a CSCS account, and start trading Nigerian stocks today.
