By Naz Daud
http://www.citylocal.co.uk
©
2007
When making an investment of any kind, one key factor
that needs to be looked at is risk versus reward. More importantly, how much risk
can you handle? A person's risk tolerance is closely linked with their willingness
to invest.
So what is "risk"? In the context
of business, "risk" is a concept that assigns a possible negative impact
to an asset or something of value that may arise from some present process or
future event. In everyday usage, "risk" is often used with the probability
of a known loss.
Here is an example; if I invest my savings
into something that could generate a profit for me, what is the possibility that
I could loose some of it or even all of it? This is a very simple way of looking
at it. For some people, the possibility of even losing 10% might be too much.
If it is, clearly the risk is too high. For another person, the risk may be too
low and would be prepared to loose all of it for potential profits.
This
brings us to the risk versus reward scenario. Risk and reward go hand in hand
and the potential reward and the probabilities may be high enough for you to raise
your level of risk. In business, there is a constant battle of finding that balance
between these two opposing forces.
Generally, the less
the reward, the lower the risk and vice versa, although this is not always the
case.
Here are a couple of examples;
- A stock
investor speculates on the stock markets and knows that if the markets move in
his direction, he may be able to double or even triple his money. Conversely,
he may stand to loose the lot or even a large portion of it if the market runs
against him. He is prepared to take the risk because the lure of large financials
gains and the pleasure he may get if he profits far outweighs the pain he will
feel if he looses. Clearly he has a high risk tolerance.
- A property
investor knows of a property that will give him a small profit he purchased a
house and sells it in 3 months after renovation. The investment is high but the
chance of losing is very low and even if he does, the amount relative to his investment
is only a small portion. This kind of investor has a low risk tolerance.
So
what factors determine your risk tolerance? There a number of factors but the
main ones are:
- How much assets does your business have
to risk? This will also determine the investments that can be examined.
-
Are you the kind of person who like the thrill of seeking large profits or would
you prefer a slow and steady growth but with less returns?
- What
is your time horizon? Do you have to cash in very quickly because your money is
under demand from other areas?
- Are you someone who constantly
worries and even looses sleep over your financial situation?
-
Is everything just a big game for you?
Whatever answers
you come up for the above, it is critical that you understand and work within
what is comfortable for you. Once you have assessed your risk levels, you can
then go about seeking investments that fall within your risk / reward scenario!
I
will leave you on one last comment - 'he who dares wins' or maybe I should say
'look before you leap'!
