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Fighting the investment risks that overshadow rewards

Would you invest in this?
Would you invest in this?
Photo by Phil Walter/Getty Images

One major aspect to risk is how long you intend to hold an investment. For example, if it is trading at a low price, the probability of permanently losing your capital in Coca Cola stock over a 15 year period is extremely low. On the other hand, day trading Coca Cola is very risky. Long-term trends need time to play out. This is something investors usually ignore. If you are investing in an asset that requires time to realize its full value, remember the six-foot tall man who drowned crossing the stream that was five feet deep on average. He got about half way through, where it was twenty feet deep.

If there is one takeaway from this fact, it is this: volatility is not your enemy. Under the right circumstances it is your best friend! Volatility creates opportunities to buy high quality assets at irrationally low prices. Unlike in baseball where a batter has to swing at the pitches thrown, investors are free to ignore the price the market offers as many times as they please. The opportunity to buy mispriced assets, in our opinion, is a positive one as long as online gambling and other investments are leveled out.

Knowledge is Power

The more you know about what you invest in, the easier it is to stay calm when necessary and make informed and prudent decisions. It is important, therefore, to work hard to research and understand the value of the underlying assets you are buying. As Peter Lynch, one of Wall Street’s most accomplished investors, once said, "Investing without research is like playing poker and never looking at the cards." This may seem rather obvious, but the truth is most investors do not understand what they are buying.

Imagine the founder of a small business. The founder knows the entire history of the company, exactly how the company makes money, how much cash is available for dividends or capital expenditures, who the main competitors are and where the opportunities exist. The founder has an excellent idea of what the company is worth. Say the founder would like to sell the business, but only at a fair price. Barring any unusual circumstances, the founder is not going to panic if he receives offers that are less than his estimate of what the company is worth. He will simply wait for an offer that he is pleased with. Investors should use the same mentality.

In the final analysis, risk is much more multi-faceted than many people give it credit for. It cannot be modeled or extrapolated with pinpoint accuracy. Certain risks matter to some investors but not others. Risk is simply an educated estimate of what the future holds. Riskier investments should offer the investor the potential for higher expected returns but also the possibility of lower returns and even losses. However, if you take the time to understand and analyze a given investment opportunity, and you trust the people you are partnering with, you will sleep well at night even as an irrational marketplace causes prices to wildly fluctuate.