Understanding Risk Key To Successful Investing
By SID SHUPACK
First State Financial, Inc.
Regardless of your particular situation, during your lifetime you will likely invest your money with the hope that it will appreciate. Your objectives may encompass a particular lifestyle, financial independence and perhaps philanthropic causes. Numerous investments are available depending on the level of risk you are willing to assume.
Risk is defined as the possibility of not achieving an expected result or suffering a loss. We take risks everyday, but they differ as to the outcome. The level we are willing to accept depends on our competence, education, experience and an understanding of the seriousness of the task. Each person makes decisions based upon their view of the opportunity. A poor perception in any of these components can distort the true risks.
Many people have lost their life’s savings after starting own their own venture. As a result, they think any investment might carry too much risk; nevertheless, there is a cost associated with avoiding decisions. For example, Treasuries and CDs are considered to be risk-free; however, after tax and inflation the returns are virtually zero. In comparison, an eight percent return per year doubles every nine years through the power of compounding.
Considering what to do today, we exclude low yield instruments because most people need a larger return in order to reach their objectives. Long-term bonds should be avoided because interest rates are at historic lows. There is a high probability rates will go up resulting in the loss of principal in they are sold prematurely. We believe that owning a business, purchasing real estate and common stocks are in fact the best avenues available depending on your particular circumstance.
In our capitalistic society, the tax laws provide lucrative incentives for investors. This creates many choices for people with innovative ideas. The level of success can be very large in a business that is run properly. However, most small businesses fail during their first three years due to insufficient capital, bad management and limited cost controls.
Real estate provides substantial tax benefits and the ability to use a significant amount of leverage. Successful real estate investing requires very specific skills. As a landlord, you are responsible for the maintenance and the management of the leases. Ownership of properties can result in significant risks if you are not a good manager, if you overpaid for the property or experience a downturn in the local economy.
Equity investments in the stock market combine many of the positive attributes of the previous examples including dividends, appreciation and to a lesser extent, the use of leverage. Despite the many similarities, stocks are uniquely different as they allow one to diversify by industry and geography, have limited liability and provide immediate liquidity. These additional benefits coupled with the fact that you’re buying experienced managers and well funded companies with cost controls in place to significantly reduce risk.
Each investor is unique; therefore it is hard to determine which investment is best for you. Some people may experience the best return by owning a business or real estate properties. However, if you’re like most, you may want to pursue a more diverse investment strategy through the use of a portfolio of common stocks. Remember, before investing you should understand the risks.
Sid Shupack, a financial and money management expert, can be reached at (918) 492-1466.
Updated 10-25-2006
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