What is Risk?
We are often told to take risks in life, but what does risk mean when it comes to investments? Risk is defined as a source of danger or possibility of incurring loss or misfortune. For example, you are taking a risk when you decide to go out the night before a big exam instead of study. You might end up failing your exam.
At first, risk sounds entirely unnecessary. Why would you do something that could possibly lead to misfortune? When you take a risk, you are not just setting yourself up for a possibility of failure, but you are also setting yourself up for the possibility of something extra.
You took the risk of failing your test so you could have a good time going out the night before. If you did not take that risk, you might have spent the time studying, but you wouldn’t have been happy staying home.
What does risk have to do with investing?
Risk plays a huge role in investing. An investment can be risky to varying degrees or risk-less. Risk-less investments are those investments backed by the governments such as government bonds or and FDIC insured savings account. Because the government backs them, you are guaranteed to get your money back. The only problem with risk-less investments is that you usually won’t get a very high return.
You have to take a risk to get a higher return which is why there are risky investments. The higher possible return on the investment, the riskier it is. The riskier the investment, the less likely you will get a return at all or even your principle investment back for that matter.
Why buy risky investments if you might not get it back?
Simple answer, a riskier investment gives a higher return. Sure, there’s a chance you might not get your money back, but that’s why you need to research your investments and weight the risks.
If you notice there are bonds for sale that offer 25% interest for a new start up company, you can’t just buy it and think “Well, I might get my $1,000 back and if I do I’ll get $1,250 back.”
Look into the company. Does it show promise? Do they seem like the’yre the kind of people that will pay you back? 25% interest is very high for a bond which would make it very risky.
On the other hand, there might be a bond that promises 8% interest from a company that has been around for a while and that you may have bought from before. Should you invest your $1,000 in this company for 8% or stay save and invest in a government bond for 4%?
This is where you need to way the risk. You decide if it’s right for you. Remember that if you don’t take any risks, you will continue to get a small return. The stock market is full of risk. You could invest in the stock market for the next 50 years and get a low historical average of a 10% return, or you could stay safe and invest in 4% interest government bonds.
Taking a little risk could mean thousands or even millions of dollars for you.
Should I always take the risk?
Generally, if you are young, take more risks, if you are older and nearing or in retirement, take very little risks. As a teenager or someone in their 20s, if you lost $25,000, you still have 20 to 30 years to get it back. If you lose that money when you are 65, you could be cutting into your living expenses in retirement.
Understand your risk and don’t always take the safe route. Take the risk and you could end up enjoying a much richer retirement sooner because of it.