101-04 Managing Risk

Managing Risk


PODCAST – Manage Risk or Get Burned… Your Choice

Do you know how to manage risk? Do you consider it as a factor before you make an investment?

  • PublishedSun, 03 Dec 2017 23:00:00 GMT
  • Duration: 00:08:15

What is Risk?

We manage risk every day.  Risk management is the process by which we decide what the potential downside of a particular deal is compared to the upside. For example, if your bank loans you $10,000 for a new car and you agree to pay back in total $10,500 in three years’ time, the bank will make a total gain of 5%.  This is the reward.

However, the bank must seek to evaluate if the reward is worth the risk.  To do this, they would like to know how much you earn, how much debt you currently have if you own your own house, and if you ever defaulted on a loan before.  They might come to the conclusion that there is a 0.5% chance of you failing to repay the loan.

This would mean that for the gain of $500 they are willing to take the risk of the loan defaulting.

The risk of 0.5% compared to the reward of 5% means the bank would have a risk-reward ratio of 1/10.  As 0.5% is one-tenth of 5%

You should try to use this method of assessing risk in your investment.  What are the chances of this bond, treasury, stock, precious metal falling in price or becoming worthless?  What will be the expected reward?

It is a common statement in the financial services industry that stocks can go down as well as up.  This is also true for all investment categories.

Diversifying Your Investment Portfolio

Diversifying your investments is a good way to achieve long term balanced growth.  Different investment vehicles behave differently at different times.  During times of recession or economic hardship, stocks perform badly and precious metals and treasuries do well.

During boom times, property and stocks outperform metals and bonds.  It can serve you well to allocate a proportion of your investments into different asset classes based on time and risk profile.

  • Low Risk – Bonds, Treasuries, Bank Account
  • Medium Risk – Housing, Property, Mutual Funds, ETF’s
  • Higher Risk – Individual Stocks
  • Highest Risk – Options, Currencies, Commodities, Spread Betting, Contracts for Difference (CFD’s)

Your goal in investing can often be determined with the spread of risk as you diversify your investment pot.

Summary

We have covered some of the fundamental questions that face you, what type of investor are you, what are your goals, and how to manage risk.

In the next section, we will look at the different types of investments you can make.