Life is full of risk. Every choice we make, from the moment we get out of bed in the morning to the moment we drift back into sleep at night, is filled with risk. It’s the human predicament to make decisions about risk and reward. Some of them are big decisions with far-reaching consequences, and some of them are trivial. But every decision that is ever made involves some level of risk.
And it is precisely because of this fact that some people delude themselves into taking unnecessary and unhealthy risks. The thinking goes like this: since every decision involves risk, then we might as well throw caution to the wind and make the decision–no matter what it is. Risk is risk, so why not take a chance? Either way, it’s a gamble, so we might as well go for it!
Here’s the problem with this line of thought: while every choice does involve some level of risk, not every choice involves the same level of risk. The most damaging myth about risk is the notion that all risk is created equal. Some decisions are riskier than others. Moreover, some decisions have lesser returns than others. If you stand in the middle of a thunderstorm holding a lightning rod while getting soaked to the bone, the risk of getting struck by lightning can be fairly high. However, there is exactly zero potential reward for engaging in such behavior.
While the rallying cry “you have to take risks to get returns” is certainly true, it does not follow that taking big risks will necessarily yield big returns. While the example above may seem odd, we do tend to make such decisions in the world of investing. We can sometimes make thoughtless investments under the belief that riskier behavior will inevitably yield higher returns. We think we’re being savvy investors, but we really just end up getting struck by lightning.
The proper way to gauge an investment’s potential risk is not by merely looking at the risk–what you stand to lose should the investment fail. You’ve also got to look at the reward–what you stand to gain should the investment prove successful. The reward-to-risk ratio is everything. If there’s a low risk investment, but the reward is also low, it typically isn’t worth your time. Likewise, if there’s a high risk investment, but the reward is also high, you may not want to bother with it. If you find an investment that involves a high amount of risk, though, but the potential returns are small, you want to avoid it like the plague. What you should be searching for are those investments that have a small amount of risk relative to the potential rewards.
All risk is not created equal. Some investments, no matter how tempting, aren’t worth pursuing because the returns are not high enough to justify the risks. If you’re looking at your portfolio and you’re having trouble distinguishing what’s too risky from what isn’t, feel free to reach out to us for a free consultation. We want to help you take the right risks, so that you can reap the right rewards and make the most of your life with your investing.