What is Risk Capital
Risk capital consists of investment funds allocated to speculative activity and refers to the funds used for high-risk, high-reward investments such as junior mining or emerging biotechnology stocks. Such capital can either earn spectacular returns over a period of time, or it may dwindle to a fraction of the initial amount invested if several ventures prove unsuccessful, so diversification is key for successful investment of risk capital. In the context of venture capital, risk capital may also refer to funds invested in a promising startup.
BREAKING DOWN Risk Capital
Risk capital should be funds that are expendable in exchange for the opportunity to generate outsized gains. It is money that can afford to be lost. Investors must be willing to lose some or all of their risk capital. It should account for 10% or less of an investor's portfolio equity and should be offset with more stable diversified investments. Speculative investing should be segmented to the early years of investing and cordoned off as retirement age approaches. Investment objectives may also change as participants start to rely more on fixed-income sources.
The more risk averse the investor, the lower the proportion of risk capital allocated in the total portfolio should be. While young investors, because of their lengthy investment horizons, can have a very significant proportion of risk capital in their portfolios, retirees may not be comfortable with a high proportion of risk capital.
Uses of Risk Capital
Risk capital is commonly utilized with speculative investments and activities. If the risk is more than proportionate to the reward, then risk capital may be considered. Investors and traders should try to accurately assess the risk prior to any investment or trade. Risk capital is often used for speculative investments in penny stocks, angel investing, lending, private equity, initial public offerings, real estate, day trading and swing trading of stocks, futures, options and commodities.
Day Trading Risk Capital
Day trading is one of the most common uses for risk capital. The pattern day trading (PDT) rule requires a day trading account to have a minimum account equity of $25,000. This allows for day trading buying power that is up to a 4:1 intraday margin. Accounts that fall under the $25,000 minimum are not allowed to make more than three roundtrip trades within a rolling five-day period. Margin is required when short-selling stocks. Failing to abide by the PDT rule can result in account restrictions and suspensions. It is important to check with the specific brokerage in regard to policies for day trading accounts.