The yin and the yang, the good and the bad. Many argue that the world is just a complex matrix of equal and opposing forces.
In the world of investing, the opposing pair that investors cannot afford to overlook is risk and reward. While a larger number of investors happily dream about exponential rewards, only a few have come to terms with the risk of losing some or all of their investments.
Without proper acceptance and management of risks, investing almost looks like gambling.
What are investment risks?
Risk is one of the most overlooked and poorly understood areas of the investing process.
Risks generally encompass everything that could go wrong in an investment.
Typically, when these happen, investors lose money. For example, investing in cryptocurrencies and expecting a surge in their prices can be very rewarding but it also poses a very high downside risk; the risk of falling prices or a complete market crash.
Understanding and managing risk is a huge distinguishing factor between reckless and prudent investors. In fact, the acceptance of risk is one of the major reasons why investors are advised to avoid “betting the farm”, i.e risking everything one owns on an investment opportunity.
This is also why investment houses, brokers and stock educators always put up financial disclaimers and advise their clients to only invest what they are willing to lose because they could in fact lose it.
What are rewards?
Rewards are simply the gains investors get from a profitable investment.
These could be in terms of money, assets, shares or residual commodities. Every investor is in it to make handsome rewards. The reward or returns depends on the initial investment amount(principal) and the return on investment (ROI).
For example, if I invested N50,000 in stocks of company XYZ and the share values appreciated by 20%, then I would have returns of N10,000.
It is however important to note that most investment opportunities that promise very high returns are also accompanied by substantially higher risks.
Investing in digital currencies for example has the potential of producing high returns but the risk of ruin is way higher compared to safer investments like bonds and treasury bills.
Risk or reward, which is more important?
By simply putting our assets into an investment we have accepted some level of risk and it isn’t a wise investment decision to have a level of risk without commensurate rewards.
The ratio between your risk to reward is called the Risk to reward ratio or simply RR.
Higher risk doesn’t guarantee a higher reward
It’s also important to keep in mind that higher-risk investments won’t automatically produce higher returns.
The risk-return trade-off merely indicates that higher-risk investments have the possibility of higher returns — but there are no guarantees.
For some, investing is all about saving for the long term and doing so in a very slow and deliberate manner. For others, short-term gains might be what’s most important.
Ultimately, it comes down to individual priorities and personal objectives.
Finding the right balance between risk and return will go a long way towards helping investors achieve their financial goals through investments that they are comfortable owning even during down markets.
FOMO is real and it’s easy to get distracted by all of the stories of huge overnight gains, blockbuster IPOs, and cryptocurrency billionaires, but the risk of not meeting your long-term goals has to be the greater concern
Research has repeatedly shown that loss aversion can meaningfully influence financial decisions.
Unfortunately, the influence it wields can cause investors to mismanage their portfolios.
The key is to focus on risk aversion, but only consider material risks and ignore the day-to-day noise of the markets. That’s why having a plan and sticking to it are so important to long-term investment success.
I prefer Rick management, because it shows me the scale of how the investment will ture out or how my returns to be.
Also shows me the step to mitigate the risk in the investment.
I do not believe that there is any human activity that is void of risk INA’s much as live forward and understand backward.
It is important, however, to develop the right attitude at each occasion.