By Martin Lee
Whenever I discuss about various investment products or ideas with others, the first question most of them will usually ask is "How much return can this investment make for me?" And inevitably, if the return doesn't seem impressively high, they will tend to lose interest without wanting to find out more details.
On the other hand, if an investment offered a very attractive return, people will rush to sign up for them, sometimes without doing the neccesary due diligence required of such investments.
While we can't fault people with wanting to maximize the returns on their investment, this one dimensional focus on returns is wrong and indeed can be very dangerous. How many times have we heard people falling prey to investment schemes that offered extremely good returns but later turned out to be too good to be true?
Take it from Singapore's Minister for Finance Tharman Shanmugaratnam, who said the following in a recent public speech: "Most fundamentally, by the fact that financial markets offer no free lunches, and that if anyone is promised higher returns it will almost always mean that he is being exposed to higher risks."
Successful investing is not just about maximizing the returns, but also on identifying and managing the risks. Returns should always be evaluated in conjunction with the risks involved.
Identifying and Managing Risks
There are two ways we can measure risks:from a quantitative point of view, and a qualitative one. Both are equally important in helping you to achieve your investment objectives.
Quantitative Risks
The quantitative part views risk on the volatility of an investment's returns. A commonly used statistical process called standard deviation gives an indication of how a price might swing, upwards or downwards in a specific time frame (usually one year).
A product with a higher volatily would be considered to be a more risky investment, while one with a lesser volatility would be considered a less risky product.
As an investor, you need to know the levels of volatility that is within your risk tolerance. Investing beyond this limit can lead to making a wrong investment decision.
For example, if you are only able to bear a 5% volatility but invest in something that has a volatility of 15%, you will end up having sleepless nights when the price drops beyond 10%. When that risk becomes intolerable, you will end up liquidating the investment at a loss - at the wrong time.
Qualitative Risks
The other part of risk looks at the qualitative aspects and understanding how it applies to you. You must know what are the risks you can undertake, and avoid those that you can't.
For example, an individual investor holding a company stock for the long term would not really be affected by the pricing risk as he does not need to sell it in the short term. On the other hand, a fund manager has less tolerance for it, as a mis-match of pricing would result in an underperformance of his funds and subsequently affect future investments into his fund.
In conclusion, always remember that successful investing requires you to understand the risks involved. Being able to identify and manage the risks of your investments can go a long way towards maximizing your returns.
Read more about personal finance, investing and trading in Singapore in Martin Lee's blog, The Lion Investor.
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How can I find the best options, given today's economy, to do this? I want to use this money as my emergency fund, budgeting my entire paycheck, to plan accordingly six months from now.
Create a savings account (or a second savings if you already have one) and start direct deposit where a certain amount of your check goes into the special savings account each time like 10 or 20 percent or an even $25 or $100 per paycheck. Then restrict yourself to only using the checking account and act like the savings account doesn't exist. Worked for me.
