What is risk? Is risk something that one should avoid? Investopedia defines risk in financial terms as “the chance that an outcome or investment’s actual gains will differ from an expected outcome or return, including the possibility of losing some or all of an original investment.”  No one likes to lose money, so of course we should avoid risk, right?  But, what about reward? Theoretically, one should be rewarded for the risk they take. The greater the risk, the greater the reward. Unfortunately, most misconstrue this mantra. Most investors have a lack of understanding of risk. Everyone wants all the reward with none of risk. This is what leads to poor decision making.

Risk is a part of every investment decision. Understanding risk. Judging risk. Appropriately dealing with risk is vital to proper investing. Risk is more than just measuring the volatility (standard deviation) of an investment. Risk is more than just determining the likelihood of the investment going to zero. Traditional finance teaches that US Dollars and US Treasuries are risk-free. Anyone paying attention to the world realizes this is ludicrous. Even after recent rake hikes, the US 3-year treasury is yielding around 2.5% when the official CPI number is over 9%.  This so-called risk-free asset is losing value throughout its lifetime.

“OK,” you may ask, “If cash is shit, what I do own? Stocks? High Yield Credit? Gold? Real Estate? Cryptos?”

There are different levels of risk and different risk scenarios one must consider. What’s your time horizon? Emotional maturity? Safety-net? Skillset? Obligations? Location? Jurisdiction? Etc. These are considerations for yourself, not even dealing with the actual risks of the asset that you’re investing. Therefore, understanding your own situation is so important. What may be too much risk for me, may not be as much risk for you.

Once you understand your own situation, then you can look to properly value the risk of your investments to gain that proper reward. Too many people are blinded by the risks of some of their assets. For example, their homes. People tend to think of their home purchase as relatively low risk. The mantra is real estate prices always go up. In reality, buildings are depreciating assets. They just deprecate at such slow rate, that inflation masks this depreciation. (Obviously, supply and demand is a factor in real estate investing, which contributes to the value of the asset. Yes, that Miami condo has seen great demand as people flock to southern Florida. But the opposite could be said of Detroit, or any other rust belt city.)  So not only are homes depreciating assets, buy many tend to ‘overbuy’ their homes, which leaves them a layoff away from defaulting on their mortgage. Without getting into liquidity or maintenance costs, a house can contain a lot of risk that the average homeowner does not consider.

As much as one can be blinded by unforeseen risks, the same investor can’t help but to fear assets that are deemed ‘too risky.’ An example of this are cryptocurrencies. The volatility of cryptocurrencies such as Bitcoin can scare investors away from investing. They see Bitcoin drop 80% in a few months, and they can not emotionally handle this volatility. This leads them to stay away from the investment class. They then scratch their heads as others make fortunes. This comes back to understanding your own situation and your own risk-level. If you are in a situation where you have a relatively short time horizon where you will need most of your assets, then yes, investing 100% of your assets into crypto could be unwise. But, what if a small percentage of your total assets may not be needed for long? Or better yet, this small percentage of your assets could be lost, and you could still survive and recover? Then why not invest a small percentage into this high volatile asset class?

I’m beginning to touch on diversification and Modern Portfolio Theory which I don’t want to explore in this post. The point I am trying to make is that you should do your due diligence. Understand yourself. Understand your own situation. Understand your own emotions. Understand the risks of your current portfolio of assets. Understand what you can lose, and what you can’t afford to lose. Beginning to understand this, will lead to making better judgements of the risks and rewards of your investment decisions. Don’t be afraid of risk. Embrace risk.

-          The Defi Fox

What is risk? Is risk something that one should avoid? Investopedia defines risk in financial terms as “the chance that an outcome or investment’s actual gains will differ from an expected outcome or return, including the possibility of losing some or all of an original investment.”  No one likes to lose money, so of course we should avoid risk, right?  But, what about reward? Theoretically, one should be rewarded for the risk they take. The greater the risk, the greater the reward. Unfortunately, most misconstrue this mantra. Most investors have a lack of understanding of risk. Everyone wants all the reward with none of risk. This is what leads to poor decision making.

Risk is a part of every investment decision. Understanding risk. Judging risk. Appropriately dealing with risk is vital to proper investing. Risk is more than just measuring the volatility (standard deviation) of an investment. Risk is more than just determining the likelihood of the investment going to zero. Traditional finance teaches that US Dollars and US Treasuries are risk-free. Anyone paying attention to the world realizes this is ludicrous. Even after recent rake hikes, the US 3-year treasury is yielding around 2.5% when the official CPI number is over 9%.  This so-called risk-free asset is losing value throughout its lifetime.

“OK,” you may ask, “If cash is shit, what I do own? Stocks? High Yield Credit? Gold? Real Estate? Cryptos?”

There are different levels of risk and different risk scenarios one must consider. What’s your time horizon? Emotional maturity? Safety-net? Skillset? Obligations? Location? Jurisdiction? Etc. These are considerations for yourself, not even dealing with the actual risks of the asset that you’re investing. Therefore, understanding your own situation is so important. What may be too much risk for me, may not be as much risk for you.

Once you understand your own situation, then you can look to properly value the risk of your investments to gain that proper reward. Too many people are blinded by the risks of some of their assets. For example, their homes. People tend to think of their home purchase as relatively low risk. The mantra is real estate prices always go up. In reality, buildings are depreciating assets. They just deprecate at such slow rate, that inflation masks this depreciation. (Obviously, supply and demand is a factor in real estate investing, which contributes to the value of the asset. Yes, that Miami condo has seen great demand as people flock to southern Florida. But the opposite could be said of Detroit, or any other rust belt city.)  So not only are homes depreciating assets, buy many tend to ‘overbuy’ their homes, which leaves them a layoff away from defaulting on their mortgage. Without getting into liquidity or maintenance costs, a house can contain a lot of risk that the average homeowner does not consider.

As much as one can be blinded by unforeseen risks, the same investor can’t help but to fear assets that are deemed ‘too risky.’ An example of this are cryptocurrencies. The volatility of cryptocurrencies such as Bitcoin can scare investors away from investing. They see Bitcoin drop 80% in a few months, and they can not emotionally handle this volatility. This leads them to stay away from the investment class. They then scratch their heads as others make fortunes. This comes back to understanding your own situation and your own risk-level. If you are in a situation where you have a relatively short time horizon where you will need most of your assets, then yes, investing 100% of your assets into crypto could be unwise. But, what if a small percentage of your total assets may not be needed for long? Or better yet, this small percentage of your assets could be lost, and you could still survive and recover? Then why not invest a small percentage into this high volatile asset class?

I’m beginning to touch on diversification and Modern Portfolio Theory which I don’t want to explore in this post. The point I am trying to make is that you should do your due diligence. Understand yourself. Understand your own situation. Understand your own emotions. Understand the risks of your current portfolio of assets. Understand what you can lose, and what you can’t afford to lose. Beginning to understand this, will lead to making better judgements of the risks and rewards of your investment decisions. Don’t be afraid of risk. Embrace risk.

-          The Defi Fox