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Identify and Manage Risk

Managing Risk is THE Single Most Important Aspect of Investment

Many ask themselves when making a decision ‘What if I’m right?’, that is, 'How much will I make?', and then rub their hands together. Now while this is a valid question, another more important question must be asked first ‘What if I’m wrong?’, that is what will happen to my balance sheet if it goes wrong.

Analyse the Deal to Find the Risks

Let’s say you find an investment that asks for $30,000 up front. You calculate that you will have $90,000 returned to you in 5 years. You are excited. But unknown to you is that there is potential to lose $50,000 all up if you don’t perform key activities and/or the market goes against you. Is this an acceptable risk to you? It certainly would not be to me. It sounds more like gambling. Maybe if you were worth millions you would risk it, but first time investors should not take risks like this.

RULE: Don’t Go Into an Investment Unless You Know Everything About It

Investments should not be exciting. They should be boring and predictable, that is, return a profit within a fixed time. If you want excitement then go play ball on the freeway, or jump out of a plane.

Create A Risk Profile

When examining an investment create a risk profile noting the following;

 
Risk

Your risk profile should be WRITTEN down before going ahead with an investment. Writing grounds your decisions and gives a firm reference point as written decisions do not change as your mind does. If you cannot determine these aspects, then do not risk it, keep researching until you know enough.

Practice The Investment First

Some aspects can only be learned by actually doing something. Paper trade, or limit the amount of money invested and write off losses as an 'educational expense'.

Risk Management Avoids Gambling With Your Money

Don’t get me wrong, there’s nothing wrong with the odd wager, but I only ever gamble what I am prepared to literally throw in the bin. I don’t like to lose. Some say ‘No risk, no reward’ and yes there has always got to be some risk, but the risk must be measurable and manageable. Only risk your surplus unneeded money, not your life, your cashflow, or your family and friends.