When approached properly, investing is the financial commitment to undertake an educated guess. How do you minimize the risks of making the wrong guess?
The Golden Rule in reducing investment risk is: Do not invest more than you can afford to lose. Obviously, no reasonable person will want to lose anything; you should consider the implications of losing 100% of the capital you are about to invest. If you put more capital at risk than you can afford to lose, you are no longer investing; you are gambling, and presumably not merely with financial obligations, but other types of obligations (e.g., family, health, education, etc.).
Are there risk considerations beyond the Golden Rule to further reduce risk? Yes, there are at least four.
1. Compare notes and strategies with someone you trust. Perhaps a friend or perhaps a professional. The most important question is: do you trust them?
2. Have access to basic and accurate financial information. You can’t make your entire investment decision(s) on gut instincts or advice from others (even if they are people you trust). You need to review at least some facts. Use the Internet, financial news magazines or newspaper, reports available through a broker, from the library, or from some trustworthy source to review some basic and fundamental facts yourself. You need to do at least some homework.
3. Spread your bets. You are investing, not gambling. Diversification, not only among investment in one type of company versus another, but in investment classes themselves (equity, debt, real estate, cash/CDs).
4. Consider investments that you understand. If you are working with a professional, they may present you with charts, discuss betas, and offer up complex investment strategies and choices you don’t entirely understand. To say that it is risky to invest in something you don’t understand isn’t particularly helpful; instead, remember to ask yourself whether you can afford to lose all the capital you place at risk with the proposal you are considering.
Mastering the Golden Rule will ensure that the risk in any investment decision you make will be manageable. Remembering one or more of the four additional steps will turn you into a successful investor who can minimize, over the long run, the risks inherent in investing.