INVESTMENT RISK- Excerpts of the book "Finance for dad"

RISK is the main factor that you should keep in mind when assessing an investment, whether it is in the financial market or an industrial or commercial business. If the analysis shows a high level of risk for your particular situation, it is best to pass on this opportunity. No matter how promising this may look. It’s just not for you. If you think you can take the risk, then go ahead and estimate the potential return and other related factors.

What aspects of risk should be considered before a financial investment?

There are three stages you have to consider when analyzing the risks of a financial investment:

• Your own capacity to take risks

• Risk of the individual portfolio components

• The average risk of the portfolio

In this order of ideas, you should first assess your own capacity to take risks. Once you know this, then you can start looking for investments that suit your level of tolerance to this matter. Finally, you should keep in mind the average risk of your portfolio.

What does “individual capacity to take risk” mean?

It is a relative concept; an investment that could be manageable for you may represent a high risk for your neighbor. Let’s see an example: Both you and your neighbor find out about a new IPO (Initial Public Offering) that will be open. This company sells pills for eternal youth. There are rumors that if investors join in, they will get a one-thousand percent profit. You are both interested in buying, but you both know that the market is unpredictable. You could lose part of your money in this adventure! The minimum investment is $10,000. You are single and you have an excellent salary, you have your own apartment and you don’t have huge commitments. Oh... Besides, you have $30,000 in your savings account. On the other hand, your neighbor is married; he has four children between the ages of 4 and 8; he barely meets the family’s expenses. He has tried hard to save $10,000 that was meant as a down payment on his first home.

-Would you say that you both have the same level of risk?

How can you manage business risk?

It is related to the likelihood of whether the business will succeed or fail. It is the type of risk that affects each business differently. It has to do with the nature of the business, costs, sales, financial management, in other words, the administration in general.

How do we handle it? Diversifying. Do not put your money in just one place, business, industry or economic sector. At this point, you must follow what you have heard before:

“Don’t put all your eggs in one basket”

The easiest way to diversify is through mutual funds. Each one of these is diversified and, in addition to this, there are specialists that assess potential threats of the entities that issue stock, individual bonds and other components of a fund. However…funds have their own risks, as we will find out later on.