Investing: When to bet the farm

Our own personalities add complexity to high-risk situations.

Bill Gurtin of Gurtin Fixed Income Management in San Diego points out the risks associated with overly emotional reactions.

"What you don't want to happen is for people to get emotional with the market," he says.

The more emotional we get, the more likely it is we will make a mistake, Gurtin explains.

A company's business prospects can be measured and evaluated statistically, but there is no easy measure for mood swings.

Before making any moves, people contemplating high-risk investments should come to grips with their emotional makeup and know how they are likely to react.

Yet successful investors take major risks all the time. They succeed because

• they do their research,
• can afford to lose the money they invest in high-risk schemes and
• are able to make up any losses they incur with other investments, which frequently involve complementary or counterbalancing risks.

Whether considering an investment in a stock, a privately held startup or a hedge fund -- all high-risk propositions -- investors should start by digging through the details of the business case to figure out how the return on investment is likely to be generated.

• How big a payoff might the investment produce?
• And how likely is success?

Successful investors look hard at the downside as well.

• What would the price of failure be?
• And how likely is that?

Professionals, even the most seasoned, have the same emotions as everyone else. Learning the ropes professionally does not eliminate human emotion, nor does it elimate urges to buy or sell emotionally. Faced with uncertainties, the tide of emotion surges. How can one resist the surging tide of emotion? Only if one has a framework of disciplines and knowledge within. Controlling emotions and replacing them with the elements of this framework are the secret.

http://myinvestingnotes.blogspot.com/2008/08/investing-when-to-bet-farm.html