Understanding Risk

Risk is a necessary element of life.  There is always the chance that something won’t work out for us and this chance is called risk.   There is a risk in anything we choose to do in life including our financial life.  We are all familiar with what risk is and most of us are used to dealing with it either on a positive basis or a negative basis.

Fundamentally, there are two types of personalities regarding risk.  Knowing which one you are is an important step in managing your investment portfolio properly.

Risk-Taker – The first type of person is the risk taker.  This is the type of person who lives for the thrill and loves to take a chance.  A person like this is perfectly comfortable in the high-risk world of options or foreign securities where the prices fluctuate by the hour.   This type of investor is at the greatest risk to lose his money because of a poor investment.   Therefore, if this is your type then you need to make sure and reevaluate your investment choices or get a second opinion from a third party.

Risk-Avoider – The second type of person is the risk avoider.  This is the person who always looks for things to not turn out good and is most likely to say, “You can’t trust anybody!”   If you know the story of “Chicken Little”, then you are familiar with the type of person we are talking about.  This type of investor is most likely to miss out on returns and end up with the same money he or she started with.  If you are this type then you need to take a look and see if maybe you are allocating a bit too much money in bonds, money markets or other fairly safe and liquid investments.  Again a third party can often help you in being objective in your evaluation.

Risk is important to understand from a wealth perspective because we are rewarded for taking risks.  The greater the risk we take, the greater the reward we will receive.  This applies to investments but also to life decisions.  In the financial world this is illustrated when we choose to invest in a stock over a safer investment.  The extra risk we take is rewarded in terms of the stocks growth.  In our personal world this is illustrated in a decision to attend college.  Attending college is essentially a case of one assuming a risk.  We are foregoing years of income for the chance that the increased education will pay off for us in more income in the long run.  This is actually a pretty safe investment that usually works.

Let’s take a closer look at the two approaches to risk.  First of all let’s talk about risk takers.  Risk takers find an extra thrill in taking risk.  They are likely to indulge in gambling, the lottery and dangerous activities such as sky diving or driving fast.  They thrive on the element of danger and risk involved in their activities.  Usually they receive an extra adrenaline rush from pursuing these activities.  As everyone knows sometimes risk works against us though and these types often suffer for their desire to pursue risks.  This personality type needs to learn to embrace safer investments and safer lifestyle options for at least some of the time.

The second approach is the conservative who never takes risks.  Though he or she is likely to live a safe life they are often unable to ever experience true wealth or any other rewards that are associated with taking risks.  It is very important for this personality type to embrace some forms of risk and accept them as a necessary element on the road to wealth.  If one always plays it safe then one will never find great rewards.  Since you only live once it is worth it to take some risks in life.  Sometimes these pay off in big ways.

Whatever personality type you are make yourself aware of how you approach risk in the different areas of your life.  Use the approach of diversification to mitigate the risk you are assuming and then make some well-placed investments that are riskier than the others.  You will be compensated for the extra risk you undertake.

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