The most important thing to think about when you are investing is a risk. Risk is the event that you are not able to recoup the initial capital you invested, regardless of what you invested in.
Different types of asset classes expose an investor to different levels of risk. Thus, deciding where to invest depends on your risk appetite. The reward for taking on risks is the opportunity to earn a return.
Risk appetite is basically how much risk you are willing and comfortable to take up, with the expectation that you will receive a return. Different types of investors have different levels of risk appetites, and they mainly fall into three categories; risk-averse, risk-neutral and risk-takers.
Risk-averse investors are those that prefer to lower their uncertainty about the outcome of an investment. In return for low risk, they get a lower return, which they prefer because there is little chance they will lose their investment. A risk-neutral investor is willing to take on a moderate amount of risk as long as the return is worth it.
On the other hand, risk-taking investors actively seek uncertainty, because they know that high risk = high return. However, since they take on more risk, there is more uncertainty about even getting that return.
If you want to preserve your capital and still earn the best returns you can, you need to balance the trade-off between risk and reward. One way to manage risk is to be consistent. You can do this by investing a specific amount of money at regular time intervals regardless of how the market is performing.
Consistency enables you to balance risk by removing emotions from the investment process and ensuring that you stick religiously to your investment strategy.
Another way to manage risk is to diversify your investment portfolio. This is just another way of saying don’t put all your eggs in one basket. When you spread your investments across different asset classes and industries, in case one asset class underperforms, it is highly probable that other investments will gain.
For example, if you divide your capital among real estate, a money market fund or other unit trust, bonds and equities, and the equities perform poorly, you still have all your other investments to fall back on. This gives you more protection than if you put all your money in just one asset class.
Lastly, think of investment as a long term activity. This helps to manage risk because it protects you from inflation. It also gives time to recover from losses recorded by the investment in the short-term. Generally, leaving your capital to grow over time, ten years or more, gives you the most value.
In conclusion, before investing, you must consider the expected returns and measure it against the underlying risk. This will help you decide whether the investment is worth your money. You should also understand what your risk appetite is.
If you are willing to set sail and go down with the ship regardless of what happens, then your expectations have to be clear right from the onset. Risk is what defines who you are as an investor.