How to Manage the Most Important Risks of Investing

Wednesday 16 June 2004

So many people invest, yet so few understand how investing really works. Let's uncover the secret: Investing is simply finding a way to get paid for taking calculated risks.

By The Landlord

Bankers understand this flawlessly. If Bill Gates and a teenager picked at random walked into a bank on the same day, both wanting a loan, who would get the better deal? Bill, of course. The bank takes virtually no risk loaning money to the world's richest man. But almost any teenager represents a considerably higher risk, and the bank expects to be paid a higher interest rate for making such a loan.

Bankers carefully calculate their risks; investors should do the same. Too many investors forget the link between returns and risks. If you're seeking above-average returns through aggressive investing, you are unavoidably taking above-average risks. And if you're seeking above-average safety, as when you invest in Government Bonds and term deposits, you will unavoidably get below-average returns.

Smart investors know how much risk is appropriate for them, and they don't exceed that level. They realise that risks come in many forms, and there is no way to totally escape them. Even if you invest in government-guaranteed bonds, you are taking a risk, as we?re about to see.

If you can recognise risks, you can manage them with relatively simple solutions. But too many investors underestimate the importance of doing this ? and it's one of the most important tasks investors should do.

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