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What are the risks involved for individual investors when investing in an IPO?

Herman Libby

Well, investing in an IPO can be exciting and potentially profitable. However, there are definitely some risks that individual investors need to be aware of. Let’s dive into some of the biggest risks:

1. Lack of information: IPOs are usually new companies that have not been around for very long. As a result, there is often limited information about the company’s financials and performance. This lack of information can make it difficult for investors to accurately assess whether or not the company is a good investment.

2. Volatility: IPOs can be incredibly volatile in the days and weeks following their initial public offering. In fact, IPOs are known for their “pop,” which is the percentage increase in stock price on the first day of trading. However, this initial pop can also be followed by a significant drop in price, leaving investors with losses.

3. Insider selling: When a company goes public, insiders (such as executives, employees, and early investors) are often able to sell their shares for the first time. This flood of selling can put pressure on the stock price and impact the value of individual investors’ holdings.

4. Lack of diversification: Many individual investors choose to invest a significant portion of their portfolio in a single IPO, hoping to capitalize on the potential upside. However, this lack of diversification can leave investors vulnerable to significant losses if the IPO doesn’t perform as expected.

5. Unproven business model: IPOs are often new companies that are still working to establish themselves and their business models. This uncertainty can make it difficult for investors to accurately assess the long-term viability of the company.

According to some statistics, investing in IPOs can be a risky proposition. A recent study found that IPOs in the US underperform compared to benchmark indices in the years following their initial offering. Additionally, a study by Jay Ritter at the University of Florida found that between 1980 and 2012, the average IPO underperformed the market in the first three years after going public.

Overall, it’s important for individual investors to carefully assess the risks involved when investing in an IPO. While there is potential for significant upside, there are also significant risks that can impact the value of your investment. As with any investment, it’s crucial to do your own research and make informed decisions.