Investing: Ignore Emotional Risks, Focus On Fundamentals

When investing, it's important to consider the risks involved. However, not all risks are created equal, and understanding the basics of risk and how it's measured can help you make informed decisions. The main risk of investing is the possibility of losing money, but there are also other factors to consider, such as the potential for significant growth or the preservation of capital. It's important to evaluate your risk tolerance and investment objectives to determine the appropriate level of risk for your financial goals.

Risk tolerance

Risk is defined in financial terms as the chance that an investment's actual gains will differ from the expected outcome or return. The main risk of investing is the possibility of losing money – you might not get back what you put in.

Your risk tolerance should inform your investing decisions. Investments should be chosen based on your objectives, needs, time horizon and tolerance for market changes. For example, if your objective is preservation of capital or protecting the assets in your portfolio, you might choose investments that involve lower risk but that also might not result in the growth or income you require.

Lower-risk investments typically contain a mix of cash and fixed-income assets. Higher-risk investments may have more equities. For example, when you invest in a mutual fund, you're buying a share in the fund itself and the assets it owns, such as stocks, bonds, or money market instruments.

Investment objectives

When investing, it is important to understand the risks and rewards involved. The main risk of investing is the possibility of losing money, and not achieving your expected returns over a particular time period. However, not all risks are equal, and it is possible to manage investing risks by understanding the basics of risk and how it is measured.

It is important to consider your risk tolerance when deciding on your investment objectives. The amount of risk you can technically afford to take may not be the same as the amount of risk you are comfortable taking. If the idea of losing money makes you uncomfortable, you may want to avoid high-risk investments. However, it is also important to keep in mind that lower-risk investments may not provide the growth or income you are looking for.

Ultimately, your investment objectives should be based on your financial goals, time horizon, and tolerance for market changes. By understanding the risks and rewards involved, you can make informed decisions about which investments are right for you.

Volatility

Market downturns can open up potential opportunities in areas of the market that were perhaps overlooked or overvalued before. Some investors can use volatility as an opportunity to add to their portfolios by buying the dips when prices are relatively cheap. You can also use hedging strategies to navigate volatility, such as buying protective puts to limit downside losses without having to sell any shares. However, put options will also become pricier when volatility is higher.

If you're seeking low volatility and steady returns, you might consider fixed-income securities. However, it's important to keep in mind that these carry interest rate risk, inflation risk, liquidity risk, call risk and credit and default risks for both issuers and counterparties.

Standard deviation

When evaluating an investment opportunity, it is crucial to consider not only the standard deviation of the asset's price but also your own risk tolerance and investment objectives. Risk tolerance refers to the amount of risk you are comfortable taking, while investment objectives encompass your financial goals and time horizon. By considering these factors together, you can make more informed decisions about which investments are suitable for your portfolio.

For instance, if your primary objective is capital preservation and you have a low-risk tolerance, you may opt for investments with lower standard deviations. These investments may provide more stable returns and help protect your capital, even if they offer limited growth potential. Conversely, if you are seeking significant growth and are comfortable with higher risk, you might consider assets with higher standard deviations. While these investments carry a greater risk of loss, they also offer the potential for substantial gains.

Historical behaviours

Risk is defined in financial terms as the chance that an investment's actual gains will differ from an expected outcome or return. The main risk of investing is the possibility of losing money – you might not get back what you put in.

When investing, it's important to consider your risk tolerance. This is the amount of risk you're comfortable taking. If the idea of losing money makes you uncomfortable, you probably don't want to pick the highest-risk investments. You might be more likely to back out early if you face volatility, which could also mean missing out on potential profits.

Your investment objectives should reflect your needs and desired outcomes, as well as the risks you're willing and able to take to meet your goals. Lower-risk investments typically contain a mix of cash and fixed-income assets, while higher-risk investments may have more equities.

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