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How does understanding risk impact our investment goals?

  • Investment Manager
  • Blog post submitted on 14th November 2017

Any investment, in any size and form, involves an element of risk; even a simple deposit in a bank account entails exposing the bank client to risk. The greatest challenge an investor will ever face is understanding and acknowledging what risks are being faced, and even more importantly, managing the potential consequences of those underlying risks. In the financial world, there are endless studies and solutions on how to manage this type of risk in anticipation of an event and not when it is too late.

The term risk inevitably takes on a different meaning to different people. For the greater part, risk is something investors might wish to avoid, whilst for others, it is merely an opportunity to take advantage of, and hence reap larger benefits in the shape of higher returns.

Put simply, risk is a financial measure of the likelihood that an investment might turn sour, or rather, not react in a way that it was expected/projected to. This means that risk is a gauge of assessing the chances of whether an investor might/might not get back some of the original invested amount or s/h might not receive as much income/interest as had been previously anticipated. This also translates into the economic concept of purchasing power, which means that investors, through an investment, might lose their financial strength to purchase something which they previously thought was within reach.

Investors, both the seasoned type as well as the unaccustomed type (through the assistance of investment professionals) must comprehend the potential negative consequents of an event on an event, and this will also determine the amount of monies/capital to be allocated to that particular investment, given the underlying risk. If an investment is perceived as too risky, or the risk-reward trade-off is not warranted or the consequence of an event happening is not acceptable, it would be advisable for the investor to shy away from those types of investments.

If an investor decides to take the plunge and expoe him/herself to a risky investment, one cannot stress the importance to have that risky exposure closely monitored and managed, and have the necessary tools in place to be able to take a timely and informed decision on whether to hold on to that investment should things take a twist for the worse (or to the better on the other extreme and valuations no longer justify the risk).

Managing the risky element within an investment portfolio is critical to achieving investment goals. Leaving risky exposure unmanaged are sure to be, in the long run, detrimental to overall performance and achieving the financial goals, and my ultimately result in an investor needing to save more or having less to spend.

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