Thursday, September 13, 2012

Risk Assessment for Beginning Investors

Managing your own investments is quite a challenge and not advised for the weak at heart, but with a little careful consideration and investigation on your part, investing can be extremely rewarding. The trick is to understand the connection between risk and investing and devise a plan to fit your investments into a risk category that you can live with.

Risk is one of those subjective concepts that might mean something different to everyone, but there are some basic guidelines that can help you come to your own conclusion. You can think of risk as either the possibility or the probability that the asset you have in mind will either not perform well or that it will lose a portion of its value. Again, it is subjective because it is subject to your predetermined assessment of how the asset should perform and how it should hold its value.

Taking an example from current life situations can help us determine what is low risk and what is high risk. Riding in a car is pretty safe, but the chances of having an accident during our lifetime are about 25% and the probability of dying from the car accident is less than 1%. Compare that to the possibility of being in a plane that comes down, which is pretty low (about one hundredth of one percent) but runs a 67% risk of dying in the experience.

While the chance of an investment  that is considered low risk (riding in an airplane) losing its value is less likely than a higher risk option (riding in a car),  the lower risk option can actually be the more devastating of the two. The investor must take into account not only the chance of loss but the possible magnitude of that loss.

By doing your homework and building a portfolio that is diverse, you can at least limit any negative swings in the market that may adversely affect your holdings.