Risk is a part of anything we do in our lives. Whether it’s taking a quick (probably illegal) turn at a junction or being around people who smoke, risk is everywhere. The riskiness of an event is often a factor in deciding to do (or not do) something. This is especially true when it comes to investing. I like to think we all try to achieve balance in all aspects of our lives.
The other side of risk is reward. Risk and reward are tied to each other in business and investing, like a teenager and their cellphone. Understanding risk is crucial in determining the likelihood of success of any investment. Investors and investment professionals try to identify potential risks and take measures to reduce its impact. This is called risk management and I’m sure you’ve heard this term before if you read my older post and reviewed your own insurance needs. Managing risks in companies is easier because they have several people dedicated to identifying potential risks, but as individual investors it is a challenge. We have to use the information available to us to make the same decisions, which makes it considerably harder to be unbiased and not overruled by our emotions. One way to improve your success in identifying risks is being aware of the economy and what is going on. It can be as simple as developing a habit of watching the news or reading the newspaper. I know there are not a lot of nice things reported but you need to understand how the economy is doing so that you are informed about any potential risks and opportunities.
Before I can talk about risk and how to reduce it, it’s important to understand the motivation to invest. I know the simple answer is to make more money. Everyone wants to make more money and spend it on things that give them joy (shout out to Marie Kondo for mainstreaming this idea). Nevertheless, as individuals, we need to take stock of ourselves before we spend a dime of what we’ve saved on any investment. This means you need to take account of your spending, through a budget. Your budget is your starting point and it will show you how and where your money goes.
Next, you need to examine your goals. This gets a little trickier because you have to think about so many things in your lives, from your relationships to your responsibilities and your hopes and dreams. You need to think about where you see yourself and try to understand your path, for example you will probably plan to get married, have kids, retire by 65 and fulfill your responsibilities to your parents and guardians in their old age. These are important considerations to make before you choose an investment and it may narrow down the options you want to take with your money and the kind of risk you are willing to take on.
When it comes to reflecting on your goals, its important to be realistic about them and not compare yourself to other people because this is a highly personal activity. It will not work if you try and put yourself in another person’s shoes or try to live someone else’s dream for you. This means that you need to take a good, hard look at yourself in the mirror. You have to be willing to get a little uncomfortable and decide where you want to go and what you are going to have to sacrifice to get there. There is no magic solution that I will propose. I am not selling you on anything. I’m just telling you what you NEED to know. Being able to live the picture you have of your future will take a lot of work and sacrifice
unless you win the lottery, then hire yourself a good financial adviser.
Back to discussing the topic at hand, risk. It’s important to reflect on your goals and dreams because it helps you determine your risk tolerance. This is something that all financial advisers do for their clients the minute they walk through their doors. Knowing your risk tolerance will allow your adviser to suggest a mix of investments for your portfolio but also it will determine the way you decide to invest. So understanding your own appetite for risk will tell you what to invest in and how you will invest (your investing style). A common question that will determine this is, “how would you react if your portfolio’s value dropped 30% tomorrow?” I’ve used a slightly exaggerated number (30% is quite high) but it makes you wonder about the situation. You can get an idea of your risk tolerance by taking this quiz and see whether you agree with its assessment or not.
Lastly, I urge you to spend time jotting down your goals, and thinking about your future before you invest. It’ll give you the reasons for investing and give you the jolt of energy you need to get your priorities in order. Some solid advice I can give you is that you should be saving a portion of your income to invest AND look at building your emergency fund. This an account (usually a savings account) to cater for 3-6 months living expenses and experts will recommend different amounts depending on your situation, I say 6 months is a good start, that way you can cover any emergency that may come up i.e. a job loss or a medical emergency and still have some savings left. It’s there to save your butt and yes, the interest earned barely beats inflation but its a safety net for you.
In the next posts I will be talking about what you need to get started to invest in the Kenyan market and introduce some terms and investment options that you may consider that won’t have you sweating over stock prices every 5 minutes. Yes, it is possible to invest and not pull your hair out when you hear about the market going bust. I’ve covered a fair amount about risk so in the next few posts I will talk about the reward side of investing. I leave you with this quote by actress and philanthropist, Angelina Jolie, that perfectly sums up what you read today:
Nature is about balance. All the world comes in pairs – Yin and Yang, right and wrong, men and women; what’s pleasure without pain?- Angelina Jolie