Investment risk assessment
In 1660 Blaise Pascal (born in France, years of life: 1623-1662) created his pioneering work on the theory of probability. He dealt with theology, but his work can be applied to risk assessment in financial markets. He was going to mathematically substantiate and bring into measurable probabilities the assumptions and conjectures about faith in God, that is, as we now say: to determine the degree of risk. His "expectations" are the basis of modern risk theory.
Together with his colleague Pierre de Fermat, Pascal came to the conclusion that people are inherently risk averse. The correspondence of these two gentlemen laid the foundations of modern probability theory.
If you apply this theory to the modern financial market, the conclusion is simple - the more risks associated with a specific asset, the more payments the investor will demand as compensation.
However, many consumers have a distorted understanding of risk and actually take it upon themselves because of this. In this article, we will look at how a misunderstanding of risk can be dangerous. It should be clear to everyone that the question of where to invest money should be accompanied by the question: What is the risk associated with this investment?
If the risks of a particular investment are low or the possible losses are lower than the profits, people are willing to take the risk. But what if the risks only seem low or the rewards are high? Then the investor faces the problem of a high risk of losing his investments, but on the other hand, there is a big profit that he can get.
Asset allocation expert Roger Gibson emphasizes that "it is rational to be risk averse", investors "should understand and prioritize all the existing dangers in any given situation". It is practically possible, but not easy.
General dangers of the real world of investments
One of the main pitfalls is that people dont realize the risk they are taking or the true magnitude of the risk in their stock portfolio. This is written about again and again in articles and books on investment. But theoretical knowledge alone cannot help. If there is no understanding, then the investor has a chance to lose.
In the financial services industry, the problem of consumer misunderstanding of risk is twofold.
First, sellers of financial products try to downplay risk in order to increase sales.
Secondly, people, tempted by huge profits, completely forget about the real risk of losing their funds in the future. Large losses in investing can be a serious blow, causing even real physical pain. Its hard to understand if youve never experienced it. But it can be imagined.
There are many examples of such losses. Investment in real estate, or rather the so-called shared construction.
An example from almost today. Not understanding the risks among the huge masses of those who want to buy apartments “cheaper” is a fact. The reluctance to correctly assess the risk of losing ones savings invested in shared construction is a fact. Everyone knows the result.
The solution to this problem is relatively easy. But only if you recognize the existence of this problem! Before using this or that financial service, this or that way of investing funds, it is necessary to collect as much information as possible. And from independent sources. And most importantly - do not lose your head. Especially if there is a promise of incredible profits.
Investments and risks. Excitement
Excitement is one of the worst enemies of an investor, especially a beginner. Few investors plan to gamble in the securities, foreign exchange, commodity or real estate markets. Initially, everyone thinks only about creating an acceptable level of investment income with minimal risk.
But passion is an insidious thing. The first successes can easily turn the investors head. Having received his first investment income, the investor begins to plan to increase them. There is nothing out of the ordinary about this. But there is a certain danger - success makes you dizzy, forcing you to underestimate the risks and overestimate your own strengths and talents. If you do not stop in time, then success and income will be replaced by failures and financial losses.
Gambling is also dangerous in case of losses. An investor who has suffered losses is often in a hurry to recover the damage. Haste is rarely good for anyone. Attempts to “win back” are fraught with new, even more significant losses.
A novice investor should not for a moment forget that investing is not a game. Investing is a serious undertaking with a certain level of risk. And this risk must be taken into account and minimized. You also need to control your mental attitude. Learning to manage yourself, not to succumb to excitement is a direct road to success in the investment field.