When you are making an investment decision, do you intentionally weigh the potential risks and rewards? Is weighing that balance more of a rational or emotional process for you? In other words, do you tend to rely more on facts or on feelings?
For investors, “risk” is defined as the chance to experience loss versus the chance to experience a gain. At one end of the risk tolerance continuum are those individuals who are averse to risk. They focus their thinking on the “loss” part of the equation. For them, risk is anxiety producing and a factor to be avoided. They want to stick with the known and predictable. In addition, those who are risk averse value financial stability above all else. Therefore, they are willing to sacrifice higher returns to achieve that sense of guarantee.
At the opposite end of the risk tolerance continuum are those who are addicted to risk. They focus on the “gain” part of the equation. For them risk is exciting and alluring; the potential for financial reward is irresistible. In order to “get rich quick,” they are willing to gamble with their money. Financially speaking, the risk-addicted get a kick out of living on the edge and taking chances.
Both of these examples of risk tolerance, risk aversion and risk addiction, are the extremes. Individuals at either end of the risk continuum operate more on feelings than on facts. Those who are either averse or addicted to financial risks are operating in economic “danger zones,” and both types are jeopardizing their long-term financial security.
Therefore, it is important to seek the middle ground on the risk tolerance continuum and to commit to becoming a calculated risk taker. In making wise financial decisions, the calculated risk taker does not avoid risk or exploit risk, but learns to manage risk.
To become a calculated risk taker, always keep in mind that knowledge is the antidote for overcoming the emotional responses that can sabotage sound investment decisions. The first step is to become aware of the underlying emotional motivators that repel you from or draw you to financial risk.
The next step is to educate yourself so that you can replace irrational responses with rational decisions. You’ll reap high returns by investing in yourself through financial education. Don’t delay—take a comprehensive financial planning course offered through work or your local community college. Read financial planning books (such as Personal Finance for Dummies by Eric Tyson and Investing on a Shoestring by Barbara O’Neill) that give sound advice based on proven principles, not the hottest trends or theories.
In addition, it is essential that you choose to work only with trusted financial professionals who support your interest in becoming a knowledgeable investor and calculated risk taker.
Reprinted by permission of Money Quotient, NP
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