Sunday, 23 December 2012

What are the 3 financial risks in an investment?

What causes financial risks in an investment?

1.  Excessive debt
"Only when the tide goes out do you discover who's been swimming naked."  - Warren Buffett. 
Companies incur debts because they want to speed up time.  They can own assets now instead of waiting for them later.  Why is speeding up time a bad thing?
These are often the companies and people with a lot of debts when the market collapses.

2.  Overpaying for an investment.
Price is what you pay.  Value is what you get.  - Warren Buffett
The asset quality has not changed.  The market conditions has not changed.  The poor investment was based on the initial price paid, not the quality of the asset.  The investor overpaid to own the asset or stock.

3.  Not knowing what you're doing.
"Risk comes from not knowing what you're doing." - Warren Buffett.
Why do people value the ownership of a house but not value the ownership of a company?
People understand how to value a house.  Many people do not understand how to value a company or stock.  They definitely do not understand the value of the company when they are broken down into many shares.  So, that is the true risk here and if you are the type of person who buys company shares and never look at what they are worth and buying on the basis that "well I like this company", you are probably setting up yourself up for buying too high above the true value of the share.

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