Whether you’re investing in insurance, pre-need plans, stocks, bonds, mutual funds, or — for that matter — going into a business venture, you’ll be faced with some amount of risk, because you’re never really 100% sure whether and how much you’ll earn from that investment.  You’re not sure because there are factors that are beyond your control that could make the return on investment more or less than what you expected or predicted. 

For example, buying garments on wholesale and then selling them retail at a good mark-up in your local neighborhood bazaar has its risks.  You may not be able to sell everything, and at the price you hoped to get.   But maybe the possible profits that you could make are worth the risks that you’re taking. That’s entrepreneurship for you.  Or you could be buying insurance from a reputable firm, then suddenly discover one day that that insurance firm itself is going bankrupt.

No investment is perfectly predictable.  Therefore, even good investments have a certain amount of risk involved.  If no one ever took any risks, then there would be no economic progress at all.  The key is to anticipate the risks, and manage the investment so that the risks are reasonable compared to the return that you expect to make. 

It’s all a matter of risk-return tradeoffs.  The higher the risk involved, the higher should you demand the returns/profits to be; otherwise you will not make the investment.

Some suggestions

Usually, when making an investment, you are attracted by the possible returns that you could make from that investment.  Most likely, you would compute potential profits, given realistic, but favorable conditions.  You could also compute potential profits should your luck really be good (assuming the return is not fixed).  Don’t get blinded by these computations, though, but seek another person’s opinion (someone whom you consider wise and unbiased), to make sure that your assumptions make sense.  Many people have been fooled by scams and swindlers who present seemingly realistic, easy-money promises, and who take advantage of an investor’s ignorance and greed.

But you shouldn’t stop there.  Before making any investment, it would be wise to anticipate and predict a “worse case” scenario to see how much you would lose, or how low your profits would go, in case something negative happens that you didn’t expect.  With a little calculation, you can determine your break-even points, and compute your remaining profits (or losses), given those worse-case situations.   Again, it helps to seek the counsel of a third-party, someone who has no stake in the investment, and certainly not the person who’s selling you the investment, to help you assess the various downside scenarios, and give you a reality check.

Then you should weigh the pros and cons of these various situations, and the likelihood of occurrence of each of these.  If the upside is likely, but the profits are not so fantastic, compared to the losses that you might incur if the downside occurs, then you would probably decide that “it’s not worth the risk.”  On the other hand, if the upside, though not so likely, is very attractive compared to the danger of losing in a downturn, then you will decide that “it’s a good investment.”

In a future blog, we will continue this discussion on risks to see lessons from the past.

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