Minimizing Risk

What is risk when it comes to investing? The simple definition is that risk is the probability of you losing your entire investment. The less you know about what you are investing in, the more you risk losing your investment.

Many Wall Street analysts like to equate risk with return but this is a fallacy. Common investment advice suggest that high rick equals high returns. However, this is not true. Risky assets often appears to yield high returns because this is what convince people to invest in them. For example, if someone asked you to invest in a gold mine in a war torn country, your first instinct would be to ask for something that would make this risk worthwhile. Typically, this compensation is a high rate of return.

However, does the high rate of return reduce your risk? Not really. Your chances of losing money are just as high no matter what the return is. It is not as life some rebel warlord is going to look at your high rate of return and call off a coup. Divorce risk from return and you will begin to evaluate risk in much better ways.

This is especially true in today’s law yield environment. Many assets are being pushed to investors such as yourself with the promise of generating high returns. The returns that these assets generate are not correlated to their risk profiles. If it were that easy to evaluate risk, everyone would construct mathematically precise portfolio all the time.

The best way to get a handle on risk is to ask yourself an acceptable level of personal risk. Everyone views risk differently. You might look at that fold mine and run away from it, but someone else might be willing to stomach the loss of the money invested in it. As an income investor, your definition of risk is pretty easy to narrow down. You are looking for assets that will generate cash flow regularly. This means these assets should be predictable or predictable as possible.