What You Can Learn From Cavemen About Investment Risk
You can’t plan financially without understanding investment risk. So, when it comes to investing it’s essential to have a solid understanding of risk. Appreciating the relationship between risk and reward could be the difference between a healthy investment portfolio and one you’d rather not talk about.Many people, when they hear about investment risk, think automatically about the chance of being defrauded or not getting all of their money back. This ‘capital’ risk is important, but it isn’t the only type. Other types of risk involve uncertainty and unpredictability. When you make an investment, it can be difficult to say with any certainty what you’ll get back when you finally cash it in. Share prices fluctuate, interest rates vary and inflation is also a risk (one which many people do not take into account when keeping money in a savings account). Just concentrating on capital risk and ignoring these other risks can mean you take too cautious an approach.
Understanding investment risk means identifying your own attitude towards it and identifying different types of risk. Once you understand the risks you can start to mitigate against them to reduce those risks and hopefully reduce them to a level you’re comfortable with.
Cavemen Understood Risk And You Must Too
Risk is a concept as old as time itself. It’s something that even our caveman ancestors would have had to consider way back when. Our prehistoric friends would have had a lot to contend with after all; danger lurked around every corner! Thinking about going on that weekly hunt? Not so fast Fred Flintstone. Have you even considered the fact that 10 minutes from now a Sabre Tooth Tiger- if it felt so inclined- could be chewing on your head like a Turkey Twizzler? Perhaps it would be better to stay in that warm, safe and (presumably furnished Barker and Stonehouse) cave.
Risk is universal. It’s basically the potential for something to go wrong and is simply defined in the Oxford Dictionary as “a situation involving exposure to danger.” Having a better understanding of risk will help you reduce your exposure to it! In the world of investing, the more you know, the better. Investing is and always has been subject to risk. No matter what it is you’re investing in or who you are investing with, there’s always risk, regardless of the investment platform or provider. Getting your head around risk when it comes to investing is as important as a well-sharpened spear was to our afore mentioned ancestors.
The return on offer will usually reflect the risk. Generally speaking, the higher the return, the higher the risk and vice versa. It’s simply a case of risk v reward!
“With inflation currently at 2.5% and the average bank interest rates around 0.5%, you could be losing up to 2% of your purchasing power every year!”
Am I Risking Potential Returns By Not Investing?
If you’re not investing your money, you could be putting your future financial security at risk and may never be able to afford the nicer things in life.What do we mean by this? By not making the most of the opportunities at hand, you could be doing yourself a disservice and actually find yourself missing out on potentially profitable investments. Think of money as a tool. By being smart with your money and using it more strategically, it won’t be long before you start to notice it adding up. Once you have a decent foothold, it’s no longer as much of an uphill struggle to generate decent returns. Sure, your money might be safer in a savings account, but, given current savings rates, it is unlikely you will receive a rate that beats inflation never mind outperforming it. And with inflation currently at 2.5% and the average bank interest rates around 0.5%, you could be losing up to 2% of your purchasing power every year!
Can You Eliminate Investment Risk?
No matter how hard you try, there’s no way of completely doing away with investment risk. You can mitigate against it and reduce your exposure of course, but you can’t eradicate it. So, what are the best ways to reduce your exposure to risk?
-Make sure you understand what you are investing in
-Do your research (aka due diligence)Decide what level of risk you are comfortable with
-Decide what level of liquidity you want (ie how quickly you want your money back when needed) Property investments tend to be very illiquid whereas stock market investments can be very quickly liquidated
-Diversify (i.e. don’t put all your eggs in one basket)
-Be realistic . Not every investment will turn out well. Don’t invest money you cannot afford to lose.
So, if you want your investments to thrive, unlike our Neanderthal friends, make sure you are well prepared to deal with risk.