Failure to Understand Risk

Risk cannot be avoided. Putting your money in a mattress risks the actual loss of the money. Depositing money in the bank risks a loss of purchasing power of the money to inflation. Risk must be identified and understood before it can be managed.

Investment theory and historical capital market return data suggest that, over long periods of time, there is a relationship between the level or risk assumed and the level of return that can be expected in an investment program. In general, higher risk is associated with higher returns.

Given this relationship between risk and return, a fundamental step in determining the investment policy for the investor’s portfolio is the determination of an appropriate risk tolerance.risk

There are many types of investment risks varying from business risk to market risk. The average investor really doesn’t care if the loss of money was caused by market risk, credit risk, or inflation, they just don’t like losing money. To manage risk, you have to understand it.

The first step is to identify actions, inactions and behavior that can lead to negative results or short-falls. This is the most critical step, because it’s difficult to control or manage a risk on which you have not focused.