Today we are going to talk about the aspects behind investments and their psychology.
We are facing the uncertainty about investing in the financial world.
The human being is in the perennial search for security thanks to a natural genetic repulse to risk to make us survive.
Risk aversion in an environment where we can be killed by beasts or adverse climatic conditions is what allowed us to survive thousands of years ago.
Many people have an innate adversion to losses.
Try to think of losing 20 euros. In this case the pain will be greater than the pleasure of having earned the same 20 euros.
This means that these people are totally opposed to certain practices that allow them to increase their portfolio .
In fact, to have an interesting economic return you have to take risks, since risk is the fuel of the potential profit.
It is also true that some zero-risk investments still exist such as bank accounts but which yield practically are below zero.
And these are not at zero risk since there is the risk of bank failure.
Therefore, it is necessary to manage the investment risk.
In the financial world, risk means exposure to the possible loss of money, or the possibility that your investments will drop in value compared to the purchase cost.
The amount of risk we are willing to expose ourselves depends on various factors like volatility.
Volatility indicates an indecision on the price on the part of sellers and buyers, certainly equates to a greater risk that can be justified by the greater possible gain.
Precisely to maximize our earnings and to analyze the risk to which we are exposed, an analysis of possible events that could affect our investments must be made, a sort of exercise to manage some risks to which we may be exposed.
Among the risks that we can easily recognize are:
a rise or fall in interest rates by the central bank, affecting corporate loans;
a credit risk, with debtors unable to pay their obligations;
a sudden inflationary push in a specific country or worldwide;
A possible country risk, as happened with Greece or Argentina;
These last two risks can be placed in a large group that we can call
market risk or systematic risk.
This is a type of risk that can affect all companies operating in a specific country or market.
We are talking about a recession, which destroys all the spending power of the population or an environmental problem that jeopardizes a specific industry, such as a disease that attacks plants destroying them all over the world.
Going more into the details of a specific market we can then talk about the specific risk of a company, like Enron in the United States.
This type of risk refers to a specific company in a national or international market and can be caused by huge scandals, or by the appearance of new international competitors on the internal market or by a new legislative change that worsens our market situation.
Remember that every investment is under this kind of risk and that systematic risk is difficult to predict in the future while specific risk can be eliminated through diversification.
But then there are assets that are not subject to risk, those safe havens where everyone can take refuge.
Yes, they exist and generally the greatest exponent is gold.
However, it should be remembered that gold also has price fluctuations and that in the event of a crisis it could have a certain decline. But here we need to understand how much the drop is, for example if gold falls by 10% in a market that dives into minus 60 or 70% …
Let’s move on to another point of view, moving from investment to investor.
The psychology and preparation of those who put money into any investments are much more important than people think. It is necessary to understand the different risk tolerance of the different people who approach the market.
This tolerance is mainly given by two factors which are the predisposition to risk influenced by one’s personality and personal financial culture, to which must be added the ability to manage emotions and the fear of losing one’s money.
Managing anxiety and maintaining clarity to better manage the situation are two very important characteristics.
Think what could happen if we panicked at every slightest downtrend or wanted to take home every little profit.
Other factors that can make this situation worse, is your relative financial situation and in which time frame you are investing for your life. Maybe that descent won’t change your life, but if you’ve used all your money on a single asset, it starts to be different.
Financial availability and your working salary are two factors that can make you feel better, combined with a long-term vision.
If we think of a personal safety net like a bank account with a good amount of money and a job with a good salary, a loss of 20% is something that we can expect. A short-term view means that risks and loss tolerance are approached differently.
The risks are generally in a short period of time, and the markets generally recover from the crisis by making new highs in a period of time that is not so long.
One last note aside, the age of the investor is also important. An elderly person is unlikely to get involved with particularly dangerous assets.
Do not focus only on volatility risk, but on real risks, on those things that are too good to be true and try to always have a long-term view.
Risk is necessary, it can be controlled but it cannot be avoided.
Learn more about safety here.