What drives you to do better at something?
When it comes to Risk do you blame your Karma, would it help or hurt you?
The risk is the most overused and misunderstood in Investing.
What do we mean by Risk? If you’ve ever come across an advertisement for a financial product, you would be familiar with a standard phrase such as, ” Mutual Fund investments are subject to market risks. Please read the Statement of Additional Information / Scheme Information Document carefully before investing”; have you really read the offer document.
Most importantly have you ever wondered what is the Market Risk they are talking about.
Are only Mutual Funds investment subject to market risk? What about investments that you are going to make.
Majority of People I have met wrongly use Risk for Losses.
Mr Market does things differently read 3 Most Important Pillars of Value Investing to Understand Mr Market.
What Do You Understand by RISK in Investing?
Everyone has its own definition of Risk.
Another misconception is “Risk and Volatility”; “The price is moving so fast every day the stock is very volatile because of that investing becomes risky” I could go on giving examples.
Knowing your Risk appetite before investing is the right thing to do to start investing. This could be done in many ways. This falls under the section of Personal Finance which I would be covering this in another post of mine.
Let us get to understanding RISK.
The Risk is to lose Money Permanently.
We believe that one person should focus on “Risk of Permanent Loss” this is a real risk in Investing.
If the value of the stock goes down for few days that is not Risk. Since Mr Market is made that way, it is right said [M]arket is voting machine in short-term and weighing machine in long term.
Permanent loss happens when the company stops its operations, burdened with too much debt, company going bankrupt, is not profitable for a very long period of time, lack of customers, making huge losses for an extended period of time all these are examples of risk to permanently lose money.
Any act of the company that could lead to permanent loss of money should be dealt with caution. This is the first thing that an investor should consider before investing.
Accepting Risk with Unknown
Mr Market does not know what is going to happen next.
Investing in stock market is like playing a losing bet. Because the reasonable estimate of performance doesn’t include so many other factors which could cause the market to fall.
Volatility does include a systematic risk while estimating future performance, but there is a certain risk which cannot be included in the market risk: a country at wars, political tension in the country, calamities, terrorist attacks, disease epidemics, could be some of the possibilities.
These are unavoidable risk in investing even the best of estimates cannot predict this. If someone happens to invest his emergency fund in the stock market and if the market is effected with any of the above reasons then it’s definitely a matter of concern.
Similarly, small-cap companies face more headwinds, this could be one of way which risk can be seen. Smaller companies have fewer resources and their own limitations which are industry specific. That’s the reason when the market is at peak and looks risky. Smart money moves into Large Cap.
Accept that market has risk which is in the hand of no one.
Risk is Must
Any attempt made to the future predictions could be a cause of failure.
One can always analyse the risk related to the company without predicting the future price movements. Great investors think for a range of possible outcomes to ensure that they have more ways to win than to lose.
The stock market is known to make you rich, [N]o one has become rich by keeping money in saving the account. Great investors work on Maring of Safety which one of the three most important pillars of value investing. That is the reason market takes money from the hand of impatient(Price Speculators) to hand of the patient.
Understanding, Calculating and Accepting the risk in investing makes it easy to manage and benefit out of it in long-term.
Risk as Leverage
This is the most common reason for risk in investing.
Taking an advance for investing in the stock market or taking an advance for the amount invested in the stock market are some of the major reason why many people lose money in the stock market.
This is the most deadly combination for Sureshot loss.
Leverage + Speculate = Sureshot Loss
The market looks lucrative to Borrow and Invest and repay; especially on unauthorised tipsters, high-profit promising companies etc.
It’s only during low tide that you come to know who is swimming naked.
This not only magnifies your losses but also ensure that you are permanently out of capital.
Volatility is not Risk
There are different types of Volatility.
The risk in investing is often understood in terms of volatility because it can be measured based on the past or historical data and performance.
There is a number of financial models which calculate and give you various values of future predictions of price movement such as Implied Volatility, Beta & Standard Deviation.
This puts an investor into a false sense of security which can then be coupled with lack of understanding of risk.
It is only prudent to understand that by using these model you are only exposed to half of the risk in the stock market investing.
Return is Not Guaranteed.
Being highly conservative and to shun the risk completely by not investing at all this often leads to being vulnerable to a lot of missed opportunities.
Based on the risk appetite taking smart risk is very important. Definitely, that does not mean more risk appetite means to take more risk and vice versa.
You should be looking to take Smart Risk or Calculated Risk.