What Are The Risks Investors Face When Investing?

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Investing is a delicate balance between risk and return. The main risk in investing is losing your capital, the main reward is increasing the size of your capital. Investing is not gambling; gambling is a game of pure luck while investing is a game of proficiency, diversification, self knowledge, control and understanding the fundamentals of the investment and the investment structure.

The risks discussed in this article are:

  • Market
  • Financial advisor
  • Too much confidence in yourself – Following only your investment Thesis
  • Inappropriate investing vehicles
  • Not investing
  • Tax inefficient

Market risks

Market risks are changes in the economic system and the trends in the share trading market which negatively impact your investments. The source of these risks are those with the power to make macro changes to the whole system acts of god,regulators, government’s and central banks. These have an agenda and objectives which are different than those of the general investor.

Market changes will be reflected in:

  • Liquidity
  • Interest Rates
  • Panic selling or buying
  • Inflation
  • Foreign countries risk
  • New Taxes
  • Windfall Taxes
  • New regulations
  • Skewing the narrative

Financial advisor risk

A financial advisor should be an independent person who gives you transparent financial advice.

Bias risk

Some financial advisors are paid commissions from the investment companies rather than their clients. If their livelihood depends on which products they sell, how can they offer a package which is in the interest of their client rather than themselves? There is a risk that funds with higher fees are presented to the clients because this is in the best interest of the “financial advisor” rather than the investor. Buyer beware.

Hard wired investing scenarios

The economy is changing and so are the investment opportunities, is your advisor aware and willing to share investing ideas and products. Or is he or she dishing out the same advice for the the last 10 years without questioning it.

Too much trust in oneself.

Some investors invest on their own without taking any advice or with consulting a book. The mechanics of investing if kept simple are straight forward but, consider that there are only 5 basic punches in boxing, but no boxer wins a match without a coach.

Common risks that investing alone can create for your portfolio

  • Thinking one can beat the market without any edge
  • Not having an exit strategy
  • Not setting conditions for exiting a trade
  • Not understanding your financial position
  • Letting FOMO and FUD make the decision

Investing in the wrong investment vehicles

There are many people out there and not of all of them are competent and friendly. Through incompetence or maliciousness some investment providers can really damage your finances.

The most dangerous investment schemes are those that are unregulated, their managers are not obliged to share information about the internal workings of the fund/product and they tend not to so. Their main argument is that disclosing too much information would be advantageous to their competitors.

Lack of transparency means that internal problems could be brewing for a very long time before they actually surface. The risks are hidden and accumulated under the carpet, and only when the hole under the carpet is too big will the investment vehicle collapse taking down your capital with it.

Following only one’s investment thesis

Investors have a vision of the future, this vision requires a number of products and services to exist and flourish. An investment thesis is investing in support of that future vision. For example a future were diesel cars will no longer exist or where flying uberified cars will be the norm. or that alternative energy will only come from solar panels.

Diversification of an investment thesis ensures that if an investment thesis is wrong or partially wrong, one need only comfort a bruised ego rather than a bruised portfolio.

Lack of portfolio structure

Early withdrawal: An emergency fund, allows one’s portfolio to live in peace to serve its long term purpose. Dipping into a portfolio for an emergency (even as a loan to the self) may mean missing out on the days where the market rises the strongest.

Wrong structure: The basic structure of a portfolio, is a balance between equities and bonds. This balance depends on your factors such as financial situation, health and family situation. Having the wrong ratio can expose you to undue risks.

Not investing: When investing is presented as an overly complicated exercise, some tend to get put off and scared away. When investing is not automated or has an overly complex structure and requires continuous time to monitor. Some investors decide simply to setup their investment another day missing out on the benefits in being in the market longer.

Lack of diversification: Having all your eggs in one basket, being one bank, one fund, one currency, one country, one continent is a form of concentration of risk. Think: “Two Is One, And One Is None”

Rebalancing: Not having a structured balancing procedure. When one asset in the portfolio grows faster than the other assets, it will expose the investor more to risks associated with that asset. Rebalancing of the assets primary objective is re-balancing of the risks.

Not dollar cost averaging: Dollar cost averaging reduces the investment risk of buying at the top.

Tax inefficient: There are structures which permit the delay of tax payment until a pension is cashed out, being aware of these systems will increase a portfolios return.

Bottling one’s investment zest

Play money is a small pot of money which one can afford to loose. Consider this as a controlled outlet for the most “imaginative” investments. Some investors need a “controlled release” into which to express their investment zest. At times it is better to keep this under control and structure it rather than to suppress.

Conclusion

Risks are a product of an investors decisions. The more one is aware of these risks, the more one can work on mitigating them. Personal Biases are hard wired internal brain pathways which shift one’s thinking into dismissing investment risk. This hard-coding fuels in built assumptions about the future, the self and our own judgment. An independent  financial adviser, who has your interest at heart can be the difference between success and failure.

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