Big payoffs often require big risks.
- Bet wrong, and you could lose everything.
- Do you have what it takes?
- And how do you assess whether a dicey investment is worth it?
You want a big return?
- How big a risk do you want to take to get it?
- Gauging the risks associated with really promising investments, and
- handling those risks appropriately, can change your life.
"It's never safe to take a risk, by definition."
- 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?
Just jump in and take a risk
- And what about all the outcomes in between?
- Successful investors tend to have a broad view, taking the downside into account with the upside.
- They plan on an outcome somewhere in the middle of the range of possibilities. That is their "expected return."
- "An expected return is an average. It's the probability of all of the outcomes."
Risk assessment gets pretty sophisticated at risk-oriented hedge funds.
- These funds combine and counterbalance risks to put together exotic investment strategies that increase an investor's upside while controlling the downside -- all for a price.
- But the basics are just common sense.
Our own personalities add complexity to high-risk situations.
- There are risks associated with overly emotional reactions.
- "What you don't want to happen is for people to get emotional with the market."
- The more emotional we get, the more likely it is we will make a mistake.
- 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.
Three ways to analyze a company
- (Quantitative, Qualitative and Technical Analysis)
- Where risk is high, the investor needs to analyze his or her life situation.
Is financial risk really risky?
- "There are times in your life when it's appropriate to take different levels of risk."
- Age is a big factor. Age changes us in a lot of ways. We gain emotional maturity. At the same time, the nature of our financial obligations changes, and the time horizon for risk gets tighter.
- "Let's say you're young, in your mid-20s," "If you take a big risk and something goes wrong, you have time to recover."
- On the other hand, the middle-aged homeowner probably needs a bigger safety net, especially if there are kids who need braces or there are college costs to consider.
- Even a high-risk investment can be a very positive part of a portfolio when it's appropriate to a person's situation and is well-managed."In investing and in life, you have to look at everything on a risk-and-reward basis. Volatility is not the end of the world."
Risk lesson from owning the business
- He left the investment firm to start his own firm.
- He knew most new businesses fail, but he had a lot of confidence in his own investment skills. If the business went under, he reasoned, he could always get a job with another firm.
- "Careers are actually the easiest place to take risks, as long as you don't burn your bridges." Younger investors, particularly, should be ready to gamble with their careers.
- But in the same breath he cautions as professional investors often do: Risk only as much as you can afford to lose, he says.
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