NAIROBI, Kenya, Oct 28 – Risk and return are synonymous with any investment decision. Many are times where people look at returns and forget the risk associated with the quest for this returns. Risk in investments should be a major consideration for investors just like the anticipated returns should be. This means that an investor’s comfort with risk or ability to withstand losses that could result from making any investment decision should be considered before making that investment decision.
Investors need to understand that markets often have cycles and they do experience upward trends and downturns. When markets experience a downturn, anxiety often takes its toll on investors who pull out of their investments in panic.
Your attitude towards market volatility is basically what comfort with risk refers to. How would you react if markets turn sharply and the value of your investments fell rapidly? Will you ignore these short-term losses and focus on the long-term returns? These are important questions that you should ask yourself before making your investment decisions.
The difficulties associated with determining your attitude towards risk are caused by three factors. One is poor investor knowledge. Some people are either ill advised or lack the knowledge to make prudent investment decisions. Such investors may make wrong investment decisions basing their decisions on expected returns thus discounting the high probability of investment loss. A prudent investor will look at the loss he or she is willing and able to bear before committing their funds to a specific investment.
For instance an investor who is not willing to lose his or her initial capital in an investment is better placed investing in cash related investments such as fixed income securities as well as bonds rather than in commodities like gold and oil or stocks that are highly volatile.
A second reason why it is difficult to determine your comfort with risk is the difficulty associated with predicting the behavior of most markets particularly those associated with high volatility such as stocks. Investors have increasingly become speculative and based their investment decisions on emotions rather than fundamentals or sound reason. It is with this in mind that they attempt to “time” markets. Market timing is often done in stock market investments and occurs when investors make their buy and sell decisions on the expected movement of markets. More often than not, market timing fails with disastrous consequences faced by the investor.
Your attitude towards risk is directly dependent on the following factors: The first is your investment objective. While some people make investments with the main objective wealth accumulation, others do so to fund their children’s education, pension planning or even t fund a long-term event like a wedding anniversary or a momentous birthday. Some people wish to accumulate substantial wealth in the long-term and will therefore be looking at high investment growth rates while others will be comfortable at securing their initial capital while generating lower returns over the period of the investment.
The investment time frame is equally important when determining attitudes towards investment risk. Investors with a short term horizon will be more inclined to selecting low risk investment instruments due to the reduced risk of loss. The opposite is true for investors with a long-term investment horizon. This is because investors with a long-term investment horizon are less likely to be swayed by short-term market volatility.
Some investors are better equipped to handle the risk associated with the volatility experienced by high risk investments because they have more resources in terms of finances to deal with such losses. Others have comparatively fewer resources and therefore opt for less risky investments.
Yes it is true, anxiety about the potential loss of an investment can even prevent one from investing. Many of us are optimistic when making investment decisions because we conveniently choose to look at the growth potential of an investment and ignore the probability that it could also lose. It is in such instances that we only find out about our comfort with risk when our investments begin to lose value and we panic into making poor investment decisions.
It is very important to throw out emotions when making investment decisions.
Attempt to predict your reaction to any sudden market movements in either direction. It’s a matter of confidence and prudence. Take your time before making any investment decisions and always contact your investment adviser to clear your doubts before making any investment decisions.