Investopedia defines risk as “Risk is defined in financial terms as the chance that an outcome or investment’s actual gains will differ from an expected outcome or return.”
Different people define risk differently for some, it could be not earning on investment or a failed investment, for some it is not being able to beat a benchmark return sounds like risk.
How should we look at risk?
- The risk would be taking permanent losses i.e. losing all your money
- Risk is having forced to liquidate all your stocks because you don’t have money to take care of expenses
- Risk is brokers calling for margins or force closing your position
- Risk is losing the financial security of your family & dependents
- Getting wiped out in business is a risk
- Not being able to do what you love to do due to work pressure is a risk
- Risk is putting yourself in situations where exists a possibility of dying even if it is 0.001 %
Let’s invert & look at what risk is not?
- Share prices moving up & down every single day is not a risk
- Losing money in a company’s share is no risk as long as that is not the only position you have
- Losing money while trying to build a business is not a risk unless you bet your entire savings on itWe need to take care of risks viewing the bigger picture. Risk in life usually comes from places which no one or very few imagined. It comes from what we don’t see. Who in his right mind would have imagined a virus shutting the world? Similarly very few had an idea that a bubble was building in 2008 which could wipe so many people out?
As Nassim Taleb says that you need to look at companies that are antifragile i.e companies that would gain instead of losing during black swan events like COVID 19, I think this model should be used by individuals too.
You have to become antifragile when it comes to managing your finances. You need to have an emergency fund that can cover your expenses for 6-12 months in case you have to. Life insurance & medical insurance to protect you & your family. Then next would be allocating the surplus money which you have left to different asset classes like gold, stock equity, debt, PPF, fixed deposits, etc. Some cash apart from all this to be ready for situations like COVID.
We need to understand that you need not chase returns always with whatever money you have. There has to be a financial plan keeping in mind your personal situation. Morgan Housel says, “ Personal Finance should be more PERSONAL than Finance”.” Read, read & reread it.
Let’s end this with some line from Warren Buffet on LTCM,
“to make money they didn’t have and didn’t need, they risked what they did have and did need. That is foolish”