Time, outcomes and risk - a simple experiment
Investing is more than just finance, it is also a measure of your time, risks and desired outcomes. Here's a simple experiment to explore that.
You know what the concept of risk is already. If you’ve jumped from a place too high, or into water too deep - you have already made the risk-reward calculation in your head - the one of thrill vs breaking a neck. You’ve calculated the risk of being rejected, even when you asked someone out for a date!
The problem of risk when it comes to investing, is similar, but it is quantified and you can use it to guide your investing decisions. You have to choose your own risk-reward equation and it is really based on - your own self! Your sibling, significant other or your BFF - all have their own risk tolerance.
But, for the sake of this lesson let's stick with financial risk. Now, this thought experiment below, is by no means a scientific one.
Sit with a paper and pen. And consider this - if you had 2 options to invest, which one would you choose and why?
- Invest $100 - wait for 2 weeks. You get $500 OR $0
- Invest $100 - wait for 2 years. You get $150 OR $90
Whatever your answer is, note it down. And now, keep adding 0s to all the $ numbers.
E.g.
- Invest $1000 - wait for 2 weeks. You get $5000 OR $00
- Invest $1000 - wait for 2 years. You get $1500 OR $900
Do it sincerely and you will get a sense of how you think about the amount of investment, the outcome - gain or loss, time and expectations work for you.
Usually, people are OK with losing a little money, as long as the upside is massive. This is how a lottery works - you buy tickets for a few bucks and hope for that massive jackpot.
This isn't all that different to much of the crypto world - people buy a little of multiple coins and hope one of them will hit a home run.
On the other hand, investing in regular stock markets - equities, bonds, ETFs etc - is not a lottery ticket, although there are people who are convinced it is. If you have taken time to understand how the markets work, how to value stocks, have a longer time frame and manage your expectations on the return you can get, stock markets are possibly a good place to invest.
But, even within the stock market, it does not mean there are no investing options that mimic a lottery system - where there is no basis or underlying reason for price movement On the whole though, there is more structure and logic behind how the markets work, compared to the plain dumb luck that’s the basis for lottery system.
So the key question - how do you manage risk? It all comes down to 2 things - Allocation & Diversification. But that’s for another day.
Meanwhile, if you want to learn more about risk and how to make it your friend when it comes to investing? Here is a nice article that explains it.
#investresponsibly
Read more: Which stocks should I buy?