Generally, in our life, we function by reducing the risks, for example, we avoid the risk of accidents by not driving too fast, or we avoid the risk of hurting ourselves by wearing a helmet while riding a bike. What if I tell you that taking risks can be beneficial to you when you are investing? Yes, it is true. Risk in finance can be defined as a measure of volatility and the extent to which there are periods of high or low during the time frame someone has invested.
Opportunity is the ability to detect and manage risks in a way that leads to market success or innovation. Where high risk can be related to a roller coaster ride, low risk can be taken as a slow-moving river. Risk and opportunities are like two sides of the same coin. Managing risk and opportunity is a continuous process that involves regular monitoring and assessment. Standard deviation, beta, Value at Risk (VaR), and the Capital Asset Pricing Model (CAPM) are some of the metrics that can be used to measure risk.
Risk is a term normally used in a negative way, whenever someone who is new to investing hears about the investment risk, they become conscious. It is a common assumption that risk means losing all the money a person has which is somewhat true under some circumstances such as when someone engages in “high-risk” investments.
However, it is an interesting scenario that investors are paid higher when the market is going down and when the investors are hopeless. On the other hand, when the market is going up and the investors are quite confident in their decision, the compensation is quite low. Investment behavior has its roots in human psychology and therefore emotions such as fear and greed have a major role in investing. Since there is a direct relationship between emotions and investing decisions, the psychological profile of an investor highly decides his or her portfolio performance. Every investor should know how much risk they can bear to attain the needed reward. Personality, investment goals, age, income, and time horizon are some of the factors that decide what level of risk someone can take. Generally, when investors take high risks, they expect higher returns as compensation for those risks.
If anyone wants to reduce the risk and increase their opportunity to get higher returns, they should go for diversifying their investments. If there are different types of securities involved, the portfolio will be more consistent and stable and can help the investor achieve long-term financial goals. Regular risk assessment and diversifying the portfolio are some of the important strategies that can reduce risk and increase opportunity.
