Risk, can we get serious now and talk about it?
In my previous post, I shared a simple investment strategy. Personally, I prefer calling it Risk Management, the reason being an investment is all about the risk an investor willing to take to earn the desired return. The one problem I have noticed among investors, they spend most of their time talking about
In this post, I will explore the Risk v Reward rule. Before that, let’s revisit a statement in my Which Comes First, Savings or Investments post; “Investment is based purely on Risk vs Reward rule. Most investors tend to concentrate on Reward (out of our control) and neglect the risk (within our control).”
I can’t stress enough the importance of spending more time thinking about actions within our control, the investment risk in this case and less time on out of our control results, especially investment return.
Why do we only speak about the return? I can only assume; we Malaysians are too familiar and comfortable investing in zero capital investment loss instruments.
Risk v Reward:
Around two years ago, my friend Vasanthan shared the above diagram explaining the Risk v Reward rule based on investment asset classes available in Malaysia. It’s a simple but very effective diagram for investors understanding of investment risk. At one glance, most would have noticed running your own business has the highest risk and reward. But here is the catch, as explained by Vasanthan, high risk means high reward which can also mean high loss. To simplify it:
High Risk = High Return = High Loss
Just because the word loss is missing from the Risk v Reward rule, we shouldn’t be ignoring it. Ask any business owner you know, especially the SME owners in Malaysia if it is easy to get a bank loan during the first few years running their business. The answer will be no, because from the bank point of view, they are taking too much risk lending out money to business owners who have a higher chance of failing. There is a statistic on this, something along the line majority of new businesses fail within the first three years. I’ll update here if I manage to find the statistic.
Dependent v Independent:
To understand the diagram better, let’s look at the famous linear equation “y=mx + c”. The independent variable is represented by the horizontal x axis and the dependent variable is represented by the vertical y axis. Based on the Risk v Reward diagram shared above, x is Risk (independent variable) while y is Reward (dependent variable). This clearly shows Return or Reward is dependent on the Risk taken. Therefore, investors should concentrate more on the risk taken, since it is within his/her control and concentrate less on the return.
Since high risk is
A part-time Malaysian blogger writing his thoughts online. Interest in both personal finance and economics, mainly the behavior aspect of them. I consider myself Poyo since I do not have any significant credentials in both fields, so readers beware. Thanks for reading.