Fully understanding the risks involved in investing can seem simple enough. This is because the concept of risk is, on the surface, a very simple one. It’s easy enough for some to weigh up the required input, and potential output, and calculate the risk from that. But not all types of risk are that simple. If you want your business to become involved in investing, then it’s important to know as much as possible about risks if you want to succeed here.
Basic risks and the value of assistance
Of course, some elements of risk in the world of investing aren’t that complex at all. Don’t invest more than you can afford. Don’t put your house down as collateral on a shaky bet. Don’t use your kids’ college funds. Even from a sheer analytical perspective, there are several things that present obvious risks. And it can be simple enough to assess the worth of a given risk with some basic analytical thinking.
One of the biggest mistakes that can be made in the world of investment, of course, is to ignore the sort of advice that you see above. It’s throwing caution to the wind and investing left, right, and centre without really thinking about it. Of course, this is quite obvious advice. And while there certainly are people out there who live that dangerously, they’re not all that common. People will give some thought to risks in investing. But one of the problems come from the following line of thinking. It’s impossible to predict the future, every investment is a risk, it’s all heavily abstract. So how much thought can you really put into it anyway?
This thinking is acknowledging that you can’t get enough information to completely negate risk. And this is true. But the dangerous extension of that is to devalue the information that you can get. To believe that there’s very little advice anyone can give you that’s really useful. But the fact is that any assistance you can get will probably be deeply useful. Just because investment is guessing and gambling, it doesn’t mean there’s no use in getting help. You should look into all the routes you can in order to help yourself. Someone looking into foreign currency exchange, for example, can seek the aid of a forex broker.
Remember to pay attention to risk tolerance
If we want to talk about risk in investments, then we need to take a look at risk tolerance.
An investor’s risk tolerance, to put it briefly, is an estimation of how much they can afford to risk in a given amount of time. The estimation isn’t made just off of the cash figures involved. This is where people often make a mistake. They believe that the amount of money that they have that they were willing to invest is the only thing that defines their risk tolerance. So to spend a penny more than that allotted amount is to “breach the danger zone”, pushing yourself past your risk tolerance. But it isn’t quite as simple as that; figuring it out and understanding it requires a little more nuance.
First of all, you need to determine your investment horizon. This is the amount of time that you expect to have ownership of a given asset. To put it in as binary a way as possible, it will show you whether or not you expect your investment to be long-term or short-term. It’s this amount of time – as well as the amount of money you have to hand – that determines how “risk tolerant” you can be. As a rule of thumb, short-term investments tend to be a much higher risk. However, this can depend on your definition on the amount of time you have. Someone nearing retirement won’t have a high risk tolerance when it comes to short-term investments. That is, unless they have a lot of money being kept away from investments, or if they have a lot of other assets that can balance out their overall risk.
Of course, there are several types of risk that you need to be giving thought to. It’s not all as basic as the list of very basic advice I gave in the first lines of the first section here. You need to be able to get more analytical, to consider all the types of risk you will put yourself through. Pretty much any type of investment will see you face these sorts of risks.
The first risk to consider here is liquidity risk. This is something that needs to be considered, whatever asset you’re working with. Liquidity refers to the speed at which an asset can be turned into cash. Let’s say you’ve got a car (not a good investment choice, by the way). You can sell your car for cash pretty quickly, although it’s not the fastest process in the world. It has a fairly high liquidity. Of course, you also need to consider how much the car is actually worth. Getting its full value may take a little more time that, say, selling it for half that.
Stocks tend to have a very high liquidity, as they can be sold for cash almost instantly. A house, on the other hand, could be sold quickly, but the time it will take to actually get the money back into your hands will be quite long. So a house will have low liquidity. This is a risk because you may find yourself in a position where you need fast access to the money tied up in that asset.
This is a fairly easy one to understand, so I’ll keep it brief. Concentration is the act of putting a lot of something into a given element. In terms of finance and investing, this refers to putting all your money in one type of asset. If we take the foreign exchange example again, we could say that investing your money only in GBP would be a mistake. And no, not just because of Brexit – because you’re concentrating all of your risk in one asset! Having some money in USD, EUR, JPY, and others will spread your risk – thus, lessening it.
Short version: don’t put all your eggs in one basket!