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"I returned, and saw under the sun, that the race is not to the swift, nor the battle to the strong, neither yet riches to men of understanding, nor yet favor to men of skill; but time and chance happeneth to them all." Ecclesiastes 9:11 "The torrent of precautions often exceeds the dangers to be avoided." Napoleon Bonaparte Risk and Reward The object of any personal investment strategy should be to accumulate the largest pool of assets that you can. Fear of loss is what prevents most people from getting ahead. The future is always uncertain, one can never know with certainty what the future value of their investment will be. Compound this with the possibility of inflation or the relative strength of the dollar, we know even less about our purchasing power in the future Risk is essentially the degree of uncertainty regarding the outcome of a decision. We as investors naturally choose investments that we perceive as having the highest return relative to the risk of losing our money. Academics tell us that, on average, the greater the risk the greater the probable return. This concept is not very practical and we must be careful that we do not assume that risk equals return. More important than the risk of loss is the consequence of the loss. Even if the chance of loss is small the consequences can be so serious (such as the possibility of getting struck by lightning) that the individual must either avoid the risk altogether, or insure against it. Consider the risk tolerance between an elderly widow living on a modest income vs. a young high salaried executive. Obviously they will not suffer the same consequences of financial loss because of the widows age and her inability to replace value lost. Loss is the unpleasant possible outcome to any investment activity, but we should also ask some questions about the consequences of the possible gain. To what extent would a larger pool of assets improve the lifestyle of the investor. A widow with less than $100,000 to her name may live an entirely different life style if she had $200,000, while a multi-millionaires lifestyle may not be effected if his portfolio remained the same or doubled overnight. I was told a story about a man in his mid 50's who had lost his job two years earlier and had only $15,000 left to his name. He did not have very good prospects of finding work and he realized that if he lost the entire $15,000 "playing the market" he would be broke just one year sooner than if he had just used the money to cover his, by then, modest living expenses. He bought three of the hottest stocks in the market and parlayed the $15,000 into $200,000 within a year. Since everyone obviously wants to make as much money as possible, the determining question in structuring an investment portfolio is balancing the risk of loss with the consequence of gain. This is a very subjective decision since some people never feel rich enough, while others would prefer to go broke next year than take a chance this year. Risk taking is often a good strategy in a deeply depressed markets. It is usually a poor strategy in an overvalued market. Investment Pyramid There is a generally accepted investment pyramid where one begins there investment portfolio by saving cash and investing overtime in higher return and risky investments. One should start his investments with liquid safe investments that build a base for the riskier investments to rest, before moving on to the next level where liquidity and safety are not as assured. |