Taking risks is essential for anyone who wants to enjoy financial rewards.
But developing an understanding of risk and its relationship with human behaviour is essential, in order to take risks in an intelligent manner.
Let’s look at four important aspects of risk:
- Risk: to expose something of value to danger or loss
- Reward: a thing given in recognition of service, effort or achievement
- Fear: an unpleasant emotion caused by the threat of danger, pain or harm
- Greed: intense and selfish desire for something, especially wealth, power or food
Investors often discuss these four in pairs:
- Risk and reward
- Fear and greed
The level of risk someone is prepared to take should be calculable and based on:
- Available capital (current and future)
- Income available now
- Income and capital requirements in the future
But it isn’t.
We are human beings and our behaviour is not always rational.
We are subjected to emotions – both as individuals and as a collective – such as fear and greed.
Fear can stop us investing in a great opportunity, while greed can lead us to invest in questionable schemes.
But fear and greed are both natural and necessary for us to survive as a species.
These two emotions arguably led us to the modern world we live in today. After all, without the greed for power and wealth, would we have had the industrial revolution, or the massive leaps in technology driven by the arms race?
However, when it comes to investment, fear and greed can be our biggest downfall.
Bitcoin is a hot-topic in finance – so let’s look at two recent bitcoin-related BBC headlines.
- ‘Bitcoin price soars to new record high of $10,000’, BBC News, 28th November
- ‘Bitcoin plunges to $10,000, half its record value’, BBC News, 17th January
Just eight weeks apart and with the same price, yet the BBC use wildly different headlines – demonstrating the conundrum of fear and greed.
I don’t own bitcoin. I wish I’d bought some five years ago. I am really glad I didn’t buy some last month. I might well wish I had bought some last month, in five years – but on the other hand, I might be relieved I didn’t!
Everyone wants to know the outcome of their investment decisions in advance.
Unfortunately, this isn’t possible. So, my advice is always to take risks that you need and can afford to take. And try to remove emotion from the process and trust in your decision-making abilities – whether you’re in tough or opulent times.
Only take risks that you need to. So, if you have enough money, invest in a way that will provide the income you need and arrange your affairs in a manner that ensures your assets are protected and given to the people you care about most, when you are gone.
Whereas if you don’t have enough money, evaluate what you need now and what you might need at a later date. It’s likely that the effort of economising will reward you later.
Rarely in life are we rewarded for nothing – so why should investing be any different?
Submitted by Stephen Langton, Blackden Financial